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Pricing and Hedging Credit Derivatives with Copulas
Author(s) -
Cherubini Umberto,
Luciano Elisa
Publication year - 2003
Publication title -
economic notes
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.274
H-Index - 19
eISSN - 1468-0300
pISSN - 0391-5026
DOI - 10.1111/1468-0300.00112
Subject(s) - copula (linguistics) , credit derivative , arbitrage , econometrics , credit default swap , economics , credit risk , valuation of options , computer science , actuarial science , financial economics
In this paper, we apply a copula function pricing technique to the evaluation of credit derivatives, namely a vulnerable default put option and a credit switch. Also in this case, copulas enable one to separate the specification of marginal default probabilities from their dependence structure. Their use is based here on no–arbitrage arguments, which provide pricing bounds and easy–to–implement super–replication strategies. At a second stage, we specify the copula function to be a mixture one. In this case, we obtain closed form prices and hedges, which we calibrate on real market data. For the sake of comparison, we add a Clayton calibration. (J.E.L: G11, G12).