Basket Default Swaps, CDO’s and Factor Copulas

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Basket Default Swaps, CDO's and Factor Copulas

by Jean-Paul Laurent of the University of Lyon & BNP Paribas, and
Jon Gregory of BNP Paribas

September 2003

Abstract: We consider a factor approach to the pricing of basket credit derivatives and synthetic CDO tranches. Our purpose is to deal in a convenient way with dependent defaults for a large number of names. We provide semi-explicit expressions of the stochastic intensities of default times and pricing formulae for basket default swaps and CDO tranches. Two cases are studied in detail: mean-variance mixture models and frailty models. We also compare prices under Gaussian and Clayton copulas.

JEL Classification: G13.

Keywords: default risk, copulas, factor models, basket default swaps, synthetic CDO's.

Published in: Journal of Risk, Vol. 7, No. 4, (Summer 2005), pp. 103-122.

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