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BSLP: Markovian Bivariate Spread-Loss Model for Portfolio Credit Derivatives

by Matthias Arnsdorf of JP Morgan, and
Igor Halperin of JP Morgan

March 2007

Abstract: BSLP is a two-dimensional dynamic model of interacting portfolio-level loss and loss intensity processes. It is constructed as a Markovian, short-rate intensity model, which facilitates fast lattice methods for pricing various portfolio credit derivatives such as tranche options, forward-starting tranches, leveraged super-senior tranches etc. A semi-parametric model specification is used to achieve near perfect calibration to any set of consistent portfolio tranche quotes. The one-dimensional local intensity model obtained in the zero volatility limit of the stochastic intensity is useful in its own right for pricing non-standard index tranches by arbitrage-free interpolation.

JEL Classification: G13, C14.

Keywords: Portfolio credit risk, default correlation, top-down, credit exotics.

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