
 Utility Valuation of Multiname Credit Derivatives and Application to CDOs by Ronnie Sircar of Princeton University, and July 2008 Abstract: We study the impact of riskaversion on the valuation of credit derivatives. Using the technology of utilityindifference pricing in intensitybased models of default risk, we analyze resulting yield spreads in multiname credit derivatives, particularly CDOs. We study first the idealized problem with constant intensities where solutions are essentially explicit. We also give the large portfolio asymptotics for this problem. We then analyze the case where the firms have stochastic default intensities driven by a common factor, which can be viewed as another extreme from the independent case. This involves the numerical solution of a system of reactiondiffusion PDEs. We observe that the nonlinearity of the utilityindifference valuation mechanism enhances the effective correlation between the times of the credit events of the various firms leading to nontrivial senior tranche spreads, as often seen from market data. Keywords: Credit derivatives, indifference pricing. Published in: Quantitative Finance, Vol. 10, No. 2, (February 2010), pp. 195208. Previously titled: Utility Valuation of Credit Derivatives and Application to CDOs This paper is republished as Ch.15 in... Books Referenced in this paper: (what is this?) 