The Art of Credit Derivatives: Demystifying the Black Swan

by Joao Garcia (Dexia Group, Brussels, Belgium); Serge Goossens (Dexia Group, Brussels, Belgium )

• ISBN13: 9780470684962
• ISBN10: 0470684968
• Format: eBook
• Copyright: 2010-02-01
• Publisher: Wiley

Summary

Credit derivatives have been instrumental in the recent increase in securitization activity. The complex nature and the size of the market have given rise to very complex counterparty credit risks. The Lehman failure has shown that these issues can paralyse the financial markets, and the need for detailed understanding has never been greater.The Art of Credit Derivatives shows practitioners how to put a framework in place which will support the securitization activity. By showing the models that support this activity and linking them with very practical examples, the authors show why a mind-shift within the quant community is needed - a move from simple modeling to a more hands on mindset where the modeler understands the trading implicitly.The book has been written in five parts, covering the modeling framework; single name corporate credit derivatives; multi name corporate credit derivatives; asset backed securities and dynamic credit portfolio management.Coverage includes: groundbreaking solutions to the inherent risks associated with investing in securitization instruments how to use the standardized credit indices as the most appropriate instruments in price discovery processes and why these indices are the essential tools for short term credit portfolio management why the dynamics of systemic correlation and the standardised credit indices are linked with leverage, and consequently the implications for liquidity and solvability of financial institutions how L_vy processes and long term memory processes are related to the understanding of economic activity why regulatory capital should be portfolio dependant and how to use stress tests and scenario analysis to model this how to put structured products in a mark-to market-environment, increasing transparency for accounting and compliance.This book will be invaluable reading for Credit Analysts, Quantitative Analysts, Credit Portfolio Managers, Academics and anyone interested in these complex yet important markets.

Table of Contents

About the Authors

Acknowledgements

Preface

List of Tables

List of Figures

Introduction

Modeling Framework

Default Models

Introduction

Default

Default Models

Modeling Dependence with Copulas

Introduction

Copula

Using Copulas in Practice and Factor Analysis

Single Name Corporate Credit Derivatives

Credit Default Swaps

Introduction

Credit Default Swap: A Description

Modeling CDSs

Calibrating the Survival Probability

2008 Auction Results

The Big Bang Protocol

Pricing Credit Spread Options: A 2-factor HW-BK Algorithm

Introduction

The Credit Event Process

Credit Spread Options

Hull-White and Black-Karazinsky Models

Results

Conclusion

Counterparty Risk and Credit Valuation Adjustment

Introduction

Valuation of the CVA

Monte Carlo Simulation for CVA on CDS

Semi-analytic Correlation Model

Numerical Results

CDS with Counterparty Risk

Counterparty Risk Mitigation

Conclusions

Multiname Corporate Credit Derivatives

Collateralized Debt Obligations

Introduction

A Brief Overview of CDOs

Cash versus Synthetic CDOs

Synthetic CDOs and Leverage

Concentration, Correlation and Diversification

Standardized Credit Indices

Introduction

Credit Default Swap Indices

Standardization

iTraxx, CDX and their Tranches

Theoretical Fair Spread of Indices

Pricing Synthetic CDO Tranches

Introduction

Generic 1-Factor Model

Implied Compound and Base Correlation

Historical Study of Lévy Base Correlation

Introduction

Historical Study

Base Correlation

Hedge Parameters

Conclusions

Base Expected Loss and Base Correlation Smile

Introduction

Base Correlation and Expected Loss: Intuition

Base Correlation and Interpolation

Base Expected Loss

Interpolation

Numerical Results

Conclusions

Base Correlation Mapping

Introduction

Correlation Mapping for Bespoke Portfolios

Numerical Results

Final Comments

Correlation from Collateral to Tranches

Introduction

Generic 1-Factor Model

Monte Carlo Simulation and Importance Sampling

Gaussian Copula Tranche Loss Correlations

Lévy Copula Tranche Loss Correlations

Marshall-Olkin Copula Tranche Loss Correlations

Conclusions

Cash Flow CDOs

Introduction

The Waterfall of a Cash Flow CDO

BET Methodology

Results

AIG and BET

Conclusions

Structured Credit Products: CPPI and CPDO

Introduction

Multivariate VG Modeling

Swaptions on Credit Indices

Model Calibration

CPPI

CPDO

Conclusion

Asset Backed Securities

ABCDS and PAUG

Introduction

ABCDSs versus Corporate CDSs

ABCDS Pay As You Go: PAUG

Conclusion

One Credit Event Models for CDOs of ABS

Introduction

ABS Bond and ABCDS

Single Name Sensitivity

Multifactor Correlation Model

Monte Carlo Simulation

Results

Conclusions

More Standardized Credit Indices: ABX, TABX, CMBX, LCDX, LevX

Introduction

ABX and TABX

LevX and LCDX

CMBX and ECMBX

Indices as Indicators

1-factor Models for the ABS Correlation Market Pricing TABX Tranches

Introduction

Generic 1-factor Model

Amortizing Bond and CDS

A Simple Model for Amortization and Prepayment

ABX.HE Credit Index

Prepayment and Model Calibration

Pricing Model Implications

Conclusions

Bond Price Implied Spreads

Introduction

Bond Price Implied Spreads

Numerical Results

Dynamic Credit Portfolio Management

Long Memory Processes and Benoit Mandelbrot

Introduction

Econophysics, Fat Tails and Brownian Motion

Long-term Memory and the Nile River

Capital Asset Pricing Model

Securitization and the Credit Crunch

Introduction

Correlation and Mortgage-backed Securities

Securitization and Economic Growth

Dynamic Credit Portfolio Management

Introduction

Regulatory Capital and Basel Formulas

Portfolio Credit Risk and Economic Capital

Securitization and CDO Models

CDO Pricing

Credit Portfolio Management and Correlation Mapping

Strategic Credit ECAP Management

Conclusion

Economic Capital Allocation Approaches

Generalized Gauss Laguerre Quadrature

References

Index

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