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A Note on Efficient Pricing and Risk Calculation of Credit Basket Products

by Hans-Juergen Brasch of TD Securities

November 2004

Abstract: In this note we briefly discuss a simple mathematical method to perform efficient pricing and risk calculations of credit basket products such as synthetic CDO and CDO 2 . We assume some familiarity with credit basket products and their modelling and therefore skip some elementary facts. As part of our discussion we revisit analytical or actuarial-type evaluation algorithms recently reinvented for CDO basket modelling by credit derivatives practitioners and academic researchers. The reader will learn to understand limitations of the application of these algorithms for CDO 2 and how to reuse the quasi-linear property of credit basket products to create a "positive paradox" in Monte Carlo simulation methods: High accuracy and stability for sensitivity figures of the present value of CDO and CDO 2 structures can be achieved at a comparably lower number of simulations than those for the present value itself.

Keywords: Credit basket model, Analytical evaluation, Monte Carlo simulation, CDO.

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