The Impossible Trio in CDO Modeling
We show that stochastic recovery always leads to counter-intuitive behaviors in the risk measures of a CDO tranche - namely, continuity on default and positive credit spread risk cannot be ensured simultaneously. We then propose a simple recovery variance regularization method to control the magnitude of negative credit spread risk while preserving the continuity on default.
Year of publication: |
2010-12
|
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Authors: | Schertzer, Emmanuel ; Li, Yadong ; Khan, Umer |
Institutions: | arXiv.org |
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