Monte Carlo simulation and a semi-analytical method are used to value a basket default swap and an homogeneous Collateralized Debt Obligation (CDO). The semi-analytical technique is based on the one factor copula model proposed by J.P. Laurent and J. Gregory [1]. We study the properties of a CDO with Monte Carlo and compare the spread calculation with the one obtained by the factor model.
In the last twenty years one of the main innovations in the field of Finance has been securitization. This is the process of pooling together a portfolio and issuing liability and equity notes backed by this pool of assets. It started in the late 1970s with mortgages backed securities and it has expanded to other instruments like credit card debt, student and car loans, junk bonds, etc. Its main purpose for the originator is to transfer some of the risk to the investors and to free up regulatory capital. The main advantage for the investors is diversification: they are able to invest in products that they would not have access otherwise.
In this report we will study one of the main examples of securitization: a Collateralized Debt Obligation (CDO). This is a security that has had a tremendous growth in the last couple of years linked to the surge of the credit derivatives market. Using Monte Carlo simulation and a semi-analytical method we analyze and find the no-arbitrage price of a CDO. We explain both methods in details and compare their results. The semi-analytical method is based on the single factor copula model proposed by J.P. Laurent and J. Gregory [1] and recently used also by J.
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Valuation of a Homogeneous Collateralized Debt Obligation
