Hamerle, Alfred and Igl, Andreas and Plank, Kilian (2012) Correlation Smile, Volatility Skew, and Systematic Risk Sensitivity of Tranches. JOURNAL OF DERIVATIVES, 19 (3). pp. 8-27. ISSN 1074-1240,
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The classical way of treating the correlation smile phenomenon with credit index tranches is to choose a sufficiently flexible model and fit it to tranche market prices. In this article, the authors go a step further and try to explain the tranche prices more fundamentally without directly fitting them. To this end, they use a risk-neutral measure of the market factor that we derive from equity index options. The resulting model allows separating the premium for correlation risk from the premium for catastrophe or downside risk. They show that ignoring the high correlation risk of tranches but allowing for their downside risk explains the historical market prices fairly well. By contrast, the standard Gaussian copula model allows for the high correlation risk of tranches but disregards the specific downside risk premia.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | OPTION PRICES; |
| Subjects: | 300 Social sciences > 330 Economics |
| Divisions: | Business, Economics and Information Systems > Institut für Betriebswirtschaftslehre > Entpflichtete oder im Ruhestand befindliche Professoren > Lehrstuhl für Statistik (Prof. Dr. Alfred Hamerle) |
| Depositing User: | Dr. Gernot Deinzer |
| Date Deposited: | 19 May 2020 05:23 |
| Last Modified: | 19 May 2020 05:23 |
| URI: | https://pred.uni-regensburg.de/id/eprint/19176 |
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