The credit market grew as one of fastest markets during the last decade, but came to a complete stand still with the financial turmoil’s and credit crises during 2008. The crisis showed, that to price complex financial products, such as credit products, correctly, is essential for a markets ability to assess the imbedded risks of the these products. This paper seeks to explain the financial structure of the credit product Collateralized Debt Obligations, CDO’s, and to price these financial structures in an efficient way, that clarifies the theory of the models and the assumptions on which they are built. The paper begins by describing the underlying building blocks of the synthetic version of the CDO’s, which is the Credit Default Swaps, CDS’s. The theoretical price for the CDS’s is derived from the Hull and White. The paper continues on to describe the elements needed to price a synthetic CDO, such as probability distributions, and credit curves, until all the needed elements are explained. Then by using the Gaussian copula- and the Student t copula models to calculate and price the correlation between defaults in the CDO reference portfolio, both theoretically and empirically prices are derived. This show exactly how the models theory is implemented from theory into practice. The results are compared to empirical data, to distinguish which model fits the empirical data best, and why. The paper ends by clarifying some of the more complicated risk factors concerning CDO’s, which investor’s faces when evaluating CDO’s as investments objects.
|Educations||MSc in Finance and Accounting, (Graduate Programme) Final Thesis|
|Number of pages||82|