Abstract:
This study concerns pricing and risk measuring of Collateralized Debt Obligations (CDOs) by using a L'evy distribution/process. The paper provides a framework to price CDOs using an asymmetric depencence structure based on the Meixner distribution since it processes desirable properties such as fat-tail, skewness, and jump component. Moreover, it is relatively simple to implement comparing to other Levy processes. it is shown that the Meixner distribution can be applied to both copula and structural form approaches. Using the prices of CDOs on the CDX NA IG, the performances of the proposed models are examined and compared to those of standard models such as Gaussian copula model, double-t copula model, and correlated Brownian motion structural model. It is found that the Meixner-based models have the edge over the standard models in all cases in terms of the mean absolute pricing errors (MAPEs). Using the paired Z-test also confirms that the proposed models seem to outperform the standard ones. Additionally, the risk measures of the models are examined.
