×

Some short elements on hedging credit derivatives. (English) Zbl 1182.91210

Summary: In practice, it is well known that hedging a derivative instrument can never be perfect. In the case of credit derivatives (e.g. synthetic CDO tranche products), a trader will have to face some specific difficulties. The first one is the inconsistence between most of the existing pricing models, where the risk is the occurrence of defaults, and the real hedging strategy, where the trader will protect his portfolio against small CDS spread movements. The second one, which is the main subject of this paper, is the consequence of a wrong estimation of some parameters specific to credit derivatives such as recovery rates or correlation coefficients. We find here an approximation of the distribution under the historical probability of the final Profit & Loss of a portfolio hedged with wrong estimations of these parameters. In particular, it will depend on a ratio between the square root of the historical default probability and the risk-neutral default probability. This result is quite general and not specific to a given pricing model.

MSC:

91G70 Statistical methods; risk measures
91G20 Derivative securities (option pricing, hedging, etc.)
91G10 Portfolio theory
PDFBibTeX XMLCite
Full Text: DOI Numdam EuDML

References:

[1] L. Andersen and J. Sidenius , Extensions to the Gaussian copula: random recovery and random factor loadings . J. Credit Risk 1 ( 2004 ) 29 - 70 .
[2] T. Bielecki and M. Jeanblanc , Pricing and Hedging of credit risk: replication and mean-variance approaches . Working paper ( 2003 ). Zbl 1061.60064 · Zbl 1061.60064
[3] B. Dupire , Pricing with a smile . Risk 7 ( 1994 ) 18 - 20 .
[4] N. El Karoui , M. Jeanblanc-Picqué and S.E. Shreve , Robustness of the Black and Scholes formula . Math. Fin. 8 ( 1998 ) 93 - 126 . Zbl 0910.90008 · Zbl 0910.90008 · doi:10.1111/1467-9965.00047
[5] M. Jeanblanc and M. Rutkowski , Hedging of credit derivatives within the reduced-form framework . Working paper ( 2003 ).
[6] D. Lando , On Cox processes and credit-risky securities . Rev. Derivatives Res. 2 ( 1998 ) 99 - 120 . · Zbl 1274.91459
[7] P. Schönbucher and D. Schubert , Copula-dependent default risk in intensity models . ETH Zurich, working paper ( 2001 ).
This reference list is based on information provided by the publisher or from digital mathematics libraries. Its items are heuristically matched to zbMATH identifiers and may contain data conversion errors. In some cases that data have been complemented/enhanced by data from zbMATH Open. This attempts to reflect the references listed in the original paper as accurately as possible without claiming completeness or a perfect matching.