Do Not Forget the Cancellation - Marking-to-Market and Hedging LCDX Tranches
5 Pages Posted: 19 Mar 2009
Date Written: March, 18 2009
Abstract
Although market is busy today working on the bullet LCDS contract to remove the cancellation feature from syndicated secured loan derivatives, in their current form LCDSs and LCDX tranches are still exposed to the cancellation risk. Until recently, in lack of proper modelling framework, market practitioners neglected the cancellation risk and they priced and hedged these products as simple CDSs and CDO tranches. However, cancellation risk does matter! Especially in the current market situation. As we show here, it is more than important to take into account the cancellation risk while marking-to-market and hedging syndicated secured loan derivatives. For this purpose, we present here an easy and robust way to model the cancellation.
Keywords: cancellation risk, bullet LCDS, LCDX, tranche pricing, marking-to-market, hedging, one-factor models, base correlation, L¿vy copulas, stochastic recovery
JEL Classification: G10, G12, G13, G15, G20, G21
Suggested Citation: Suggested Citation