A generic onefactor Lévy model for pricing synthetic CDOs”. UCS-Report

Abstract

Summary. The one-factor Gaussian model is well-known not to fit simultaneously the prices of the different tranches of a collateralized debt obligation (CDO), leading to the implied correlation smile. Recently, other one-factor models based on differ-ent distributions have been proposed. Moosbrucker [12] used a one-factor Variance Gamma model, Kalemanova et al. [7] and Guégan and Houdain [6] worked with a NIG factor model and Baxter [3] introduced the BVG model. These models bring more flexibility into the dependence structure and allow tail dependence. We unify these approaches, describe a generic one-factor Lévy model and work out the large homogeneous portfolio (LHP) approximation. Then, we discuss several examples and calibrate a battery of models to market data.