Pricing of CDOs Based on the Multivariate Wang Transform

by Masaaki Kijima of the Tokyo Metropolitan University,
Shin-ichi Motomiya of the Credit Pricing Corporation, Ltd., Tokyo, and
Yoichi Suzuki of the Credit Pricing Corporation, Ltd., Tokyo

February 8, 2010

Abstract: This paper extends the one-factor Gaussian copula model, the standard market model for valuing CDOs, based on the multivariate Wang transform. Unlike the existing models, our model calibrates the parameter associated with a risk adjustment for default threshold, not correlation parameter, which always exists and is unique for any market price of CDO tranche. A Student t-copula model is also considered within the same framework to describe a fat-tail distribution observed in the actual market. Through numerical experiments, it is shown that our model provides a better fit to the market data compared with the existing models.

JEL Classification: D81, D92, G32.

Keywords: One-factor Gaussian copula model, Merton's structural model, Multivariate Wang transform, Student t copula

Published in: Journal of Economic Dynamics and Control, Vol. 34, No. 11, (November 2010), pp. 2245-2258.

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