Tom Hurd MacMaster University, Hamilton, Ontario

Fast and flexible CDO computations in the affine markov chain credit model.

Abstract:
The AMC model is a natural extension of the intensity based framework which combines credit migration and default with stochastic interest rates and recovery. It has very nice properties: when applied to one or two firms, closed formulas result for default probabilities, bond prices, and even credit default swaps, resulting in fast computation times. After describing the new approach, I will apply the method to pricing basket derivatives on large numbers of firms, specifically CDOs. The market for such products is now extremely hot, but current CDO pricing technology does not rest on a coherent consistent model. I will show how CDOs can be priced and hedged very flexibly and efficiently in the AMC modelling framework. Development issues still remain before these methods can be applied on an industrial scale, but early results are intriguing.