A Comparative Analysis of CDO Pricing Models

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A Comparative Analysis of CDO Pricing Models

by Xavier Burtschell of BNP-Paribas,
Jon Gregory of Barclays Capital, and
Jean-Paul Laurent of Université de Lyon & BNP-Paribas

April 21, 2008

Abstract: We compare some popular CDO pricing models. Dependence between default times is modelled through Gaussian, stochastic correlation, Student t, double t, Clayton and Marshall-Olkin copulas. We detail the model properties and compare the semi-analytic pricing approach with large portfolio approximation techniques. The ability of the models to fit the correlation skew observed in CDO market quotes is also assessed. Eventually, we relate CDO premiums and the distribution of conditional default probabilities which appears as a key input in the copula specification.

JEL Classification: G13.

Keywords: basket default swaps, CDOs, correlation smile, copulas, factor models, conditional default probabilities, stochastic ordering, comonotonicity, de Finetti’s theorem.

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