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Levy Process Dynamic Modelling of Single-Name Credits and CDO Tranches

by Martin Baxter of Nomura International, plc

April 27, 2006

Abstract: This paper explores further a new family of structural credit models using Levy processes, particularly the Gamma process and some variants. These dynamic arbitrage-free models can fit both CDS and CDO markets. Building on the Brownian-Variance-Gamma of the earlier paper (20 March 2006), more models from the family are introduced and compared. Goodness of fit, parameter stability, and practicality of implementation are considered, using a six month dataset of market levels to test calibration.

JEL Classification: G13.

Keywords: Structural credit model, CDO pricing, Levy process.

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