Journal of Credit Risk

CDO pricing with factor models: survey and comments

Leif Andersen, Jakob Sidenius


Models with systematic factors are popular in the modeling of CDOs, mainly owing to their simplicity and tractability. In this small note we provide a general framework which we use to survey a number of CDO models that have appeared in the literature so far. We suggest extensions and also briefly discuss a select number of issues with factor models, ranging from calibration against CDO market data (ie, base correlation skews) to credit spread hedging and maturity extrapolation. We highlight a number of inherent limitations of factor models and also discuss certain idiosyncracies of popular model-independent approaches to computation of spread hedges.

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