Pricing and Hedging Non-Standardized Synthetic CDO Tranches

• Main Authors: Heng-Chieh Hsu, 許恆杰
• Other Authors: Meng-Lan Yueh
• Format: Others
• Language: en_US
• Published: 2006
• Online Access: http://ndltd.ncl.edu.tw/handle/27465111043827241008

碩士 === 國立中央大學 === 財務金融研究所 === 94 === With the development of synthetic CDO standardized tranches, in order to fit in different investors’ risk preference, we try to value and hedge non-standardized tranches which are combined with market quotes of standardized ones. In this paper, we select a set of market quotes of standardized DJ iTraxx Europe tranches and use the Homogeneous Large Pool Gaussian Copula model to find the compound and base correlations of tranches. Moreover, we can value any non-standardized tranches by those base correlations. As to hedge non-standardized tranches, for the first-order risk, we focus on the spread risk and build up hedging positions by tranches’ deltas. We also discuss the second-order risk such as the spread convexity. We discover that the delta-hedged non-standardized equity tranche position can make investors benefit from the spread convexity. By contrast, the delta-hedged non-standardized senior tranche position can make investors suffer from the spread concavity. We also analyze the correlation risk by tranches’ correlation sensitivities. Finally, we connect the default correlation parameter with the deltas and we find that the spread risk is parceled to the senior tranche as the default correlation increases.