Multiname and Multiscale Default Modeling

Multiname default modeling is crucial in the context of pricing credit derivatives such as Collaterized Debt Obligations (CDOs). We consider here a simple reduced form approach for multiname defaults based on the Vasicek or Ornstein-Uhlenbeck model for the hazard rates of the underlying names. We analyze the impact of volatility time scales on the default distribution and CDO prices. We demonstrate how correlated fluctuations in the parameters of the name hazard rates affect the loss distribution and senior tranches of CDOs. The effect of stochastic parameter fluctuations is to change the shape of the loss distribution and cannot be captured by using averaged parameters in the original model. Our analysis assumes a separation of time scales and leads to a singular-regular perturbation problem [7, 8]. This framework allows us to compute perturbation approximations that can be used for effective pricing of CDOs.