Valuation of Credit Derivatives

Abstract

Credit derivatives are very interesting financial instrument both theoretically and practically. Their valuation has become an often discussed topic during the financial crisis since 2007. First part of this work is dedicated to standard types of credit derivatives, mainly to description of their character and to information about the historical development and also about the actual situation on the credit derivative market. However, this work is primarily focused on valuation of more complicated credit derivatives, namely Collateralized Debt Obligation (CDO), where modeling of correlation between underlying assets is required e.g. by copula functions. Then it deals with the mechanism of allocation of cash flow from underlying portfolio to CDO debt tranches, which is called financial waterfall. The goal of this work is to estimate price of a derivative by simulation methods and to examine an impact of changes in correlation structure inside portfolio, in recovery rates of assets and in other parameters of valuation. This valuation runs on real data about traded derivative, so it can be compared to its market value