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A Semi-Analytical Parametric Model for Dependent Defaults

by B.S. Balakrishna -- Unaffiliated

May 15, 2007

Abstract: A semi-analytical parametric approach to modeling dependent defaults is presented. It is a multi-factor model based on instantaneous default correlation that also takes into account higher order default correlations. It is capable of accommodating a term structure of default correlations and has a dynamic formulation in the form of a continuous time Markov chain. With two factors and a constant hazard rate, it provides perfect fits to four tranches of CDX.NA.IG and iTraxx Europe CDOs of 5, 7 and 10 year maturities. With time dependent hazard rates, it provides perfect fits to all the five tranches for all three maturities.

JEL Classification: G13.

Keywords: CDO, Credit Default, Default Correlation, Conditional Independence, Factor Model, Perfect Fit.

Previously titled: A Semi-Analytical Parametric Model for Credit Defaults

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