Chapter 6

Dynamic Hedging of Synthetic CDO Tranches: Bridging the Gap between Theory and Practice

Areski Cousin

Université de Lyon, Université Lyon 1, ISFA

Jean-Paul Laurent*

Université Paris 1 Panthéon-Sorbonne and BNP Paribas

This chapter intends to provide insights about the topical issue of risk managing synthetic collateralized debt obligations (CDOs). We stand in the gray zone between mathematical finance and financial econometrics, between academic and market practitioners’ approaches. We chose to first present two scholar models, each of them leading to perfect replication of CDO tranches with credit default swaps (CDSs). Though they rely on rather simplistic assumptions and are built upon different premises, they lead to similar hedge ...

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