A General Numerical Algorithm for CDO Pricing Based on Single Factor Copula Framework and Nonhomogeneous Assumptions

Abstract

In view of the fact that different factor Copula models are only applicable to different practical problems in collateralized debt obligations (CDO) market and that there is no semianalytical solution under nonhomogeneous assumptions to CDO pricing model, we designed a general numerical algorithm which was based on the framework of single factor Copula model and randomized quasi-Monte Carlo (RQMC) simulation method. We took two single factor Copula models as examples to conduct empirical study, in which the simulation results of RQMC and Monte Carlo (MC) simulation method were compared and analyzed based on variance changes. The result showed that the algorithm in this paper was not only applicable to general single factor Copula model but also very stable. So, it was a general and efficient numerical method to solve the problem of CDO pricing under nonhomogeneous assumptions.

Application of RQMC for CDO Pricing with Stochastic Correlations under Nonhomogeneous Assumptions

“…Qu et al [15] introduced RQMC into the CDO pricing based on a single-factor Copula framework and nonhomogeneous hypothesis and achieved good results. However, only the constant correlation coefficient was considered in the model.…”