Market-implied Archimedean copulas
Computations of implied copulas are a central element in producing loss distributions of bespoke portfolios and pricing their tranches. This process is made feasible by the availability of index tranche pricing data. Luigi Vacca shows how it is possible to calculate the implied Archimedean copulas from index loss distributions. The advantage of this method is that implied Archimedean copulas can be used to price any bespoke tranche in a consistent and easy way
The credit derivatives market has experienced explosive growth in the past decade. Banks have created and maintained a series of index portfolios, such as CDX North America and iTraxx Europe, to promote market liquidity. A set of standardised index tranches, with fixed attachments and detachments, is being traded daily by brokers and dealers in the over-the-counter market. At the same time, buyers and sellers of protection have traded tranches of customised portfolios, so-called 'bespokes'
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