Dynamic Hedging of Portfolio Credit Risk in a Markov Copula Model

• We devise a bottom-up dynamic model of portfolio credit risk where instantaneous contagion is represented by the possibility of simultaneous defaults. Due to a Markovian copula nature of the model, calibration of marginals and dependence parameters can be performed separately using a two-step procedure, much like in a standard static copula setup. In this sense this solves the bottom-up top-down puzzle which the CDO industry had been trying to do for a long time. This model can be used for any dynamic portfolio credit risk issue, such as dynamic hedging of CDOs by CDSs, or CVA computations on credit portfolios.

Subject headings

SAMHÄLLSVETENSKAP  -- Ekonomi och näringsliv (hsv//swe)

SOCIAL SCIENCES  -- Economics and Business (hsv//eng)

NATURVETENSKAP  -- Matematik -- Sannolikhetsteori och statistik (hsv//swe)

NATURAL SCIENCES  -- Mathematics -- Probability Theory and Statistics (hsv//eng)

NATURVETENSKAP  -- Matematik -- Beräkningsmatematik (hsv//swe)

NATURAL SCIENCES  -- Mathematics -- Computational Mathematics (hsv//eng)

Keyword

Portfolio credit risk

Credit derivatives

Markov copula model

Common shocks Dynamic hedging

Publication and Content Type

ref (subject category)

art (subject category)