Managing Synthetic CDO Tranches using Base Correlations
Managing Synthetic CDO Tranches using Base Correlations
Managing Synthetic CDO Tranches using Base Correlations
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Interpolation and extrapolation of base correlations<br />
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Price is extremely sensitive to the slope of the base correlation curve<br />
Abrupt change in slope can lead to arbitrage violations<br />
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How should we interpolate to maintain no-arbitrage framework<br />
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How should we extrapolate<br />
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<strong>Base</strong> correlation curve is monotonically increasing<br />
Equity tranches are riskier than constant correlation predicts<br />
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