Pricing and hedging basket credit derivatives in the Gaussian copula

Since the seminal paper of Li (2000), the Gaussian copula model has become the market standard of the structured credit derivatives world. By postulating a correlation structure for the default times of each issuer directly, this model allows the practitioner to price collateralised debt obligation (CDO) payouts and gives a simple solution for their risk management.

However, the choice of the pairwise correlations appears largely arbitrary and lacks a clear link with a concept of realised