Hedging of Credit Derivatives in Models with Totally Unexpected Default

Hedging portfolio loss derivatives with CDSs∗

In this paper, we consider the hedging of portfolio loss derivatives using single-name credit default swaps as hedging instruments. The hedging issue is investigated in a general pure jump dynamic setting where default times are assumed to admit a joint density. In a first step, we compute default intensities adapted to the global filtration of defaults. In particular, we stress the impact of a...

Dynamic Hedging of Portfolio Credit Derivatives

We compare the performance of various hedging strategies for index collateralized debt obligation (CDO) tranches across a variety of models and hedging methods during the recent credit crisis. Our empirical analysis shows evidence for market incompleteness: a large proportion of risk in the CDO tranches appears to be unhedgeable. We also show that, unlike what is commonly assumed, dynamic model...

Hedging of Basket Credit Derivatives in Credit Default Swap Market

Recent Advancements in the Theory and Practice of Credit Derivatives

In the Black-Cox model, a firm makes default when its value hits an exponential barrier. Here, we propose an hybrid model that generalizes this framework. The default intensity can take two different values and switches when the firm value crosses the barrier. Of course, the intensity level is higher below the barrier. We get an analytic formula for the Laplace transform of the default time and...

Robust Recovery Risk Hedging: Only the First Moment Matters

Credit derivatives are subject to at least two sources of risk: the default time and the recovery payment. This paper examines the impact of modeling the recovery payment on hedging strategies in a reduced-form model as well as a Merton-type model. We show that quadratic hedging approaches do only depend on the expected recovery payment at default and not the whole shape of the recovery payment...