Factor models for credit correlation
Credit default swaps (CDSs) represent insurance contracts on individual obligors, synthetic collateralised default obligations (CDOs) represent various tranches of baskets backed by CDSs, while cash CDOs are backed by corporate bonds, mortgages, and other assets. Originally, the Gaussian Copula approach was used to price CDO tranches (see, for example, Li (2000)). Unfortunately, in its basic form it is incapable of reproducing market prices. Several researchers have tried to generalise it with
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