Dynamic Hedging of Synthetic CDO Tranches with Spread Risk and Default Contagion

Rüdiger Frey, Jochen Backhaus

Publication: Scientific journalJournal articlepeer-review


The paper is concerned with the hedging of credit derivatives, in particular synthetic
CDO tranches, in a dynamic portfolio credit risk model with spread risk and default contagion.
The model is constructed and studied via Markov-chain techniques. We discuss the
immunization of a CDO tranche against spread- and event risk in the Markov-chain model
and compare the results with market-standard hedge ratios obtained in a Gauss copula
model. In the main part of the paper we derive model-based dynamic hedging strategies
and study their properties in numerical experiments.
Original languageEnglish
Pages (from-to)710 - 724
JournalJournal of Economic Dynamics & Control
Publication statusPublished - 1 Dec 2010

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