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Dynamic Modelling of Single-name Credits and CDO Tranches

by Martin Baxter of Nomura International, plc

March 20, 2006

Abstract: This paper presents a new model of the evolution of credits within a basket. This structural model uses a Levy process to have dynamics which are intuitive, which capture the heavy tails of credit distributions, and which have a correlation structure that matches CDO market prices. For practical purposes, it is useful that the model is also tractable to implement.

JEL Classification: G13.

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

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