Extreme events and default baskets

As the markets in synthetic CDOs and basket credit default swaps grow in size, copula methods,which relate reference portfolio loss distributions to underlying asset correlations, are emerging as thefavoured pricing approach within the Merton framework. However, a lively debate continues over thechoice of copula to be used. In the first of two themed articles, Roy Mashal and Marco Naldi arguethat for pricing small baskets, t copulas are essential to properly account for extreme event risk

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