CDO Parameters Estimation Using Market Prices

In this paper, we address the crucial problems of parameters estimation of Collateralized Debt Obligation (CDO). We present a methodology for fair spread estimation of reconstituted (CDO) from European market data. A fundamental part of the pricing framework is the estimation of default probabilities and the structure of dependency. We present a copula based simulation procedure for pricing CDO and we estimate parameters from market data. We extract default probabilities from the market quoted credit default swap spreads. We consider using Gaussian copula and Student copula on pricing CDO prices. We will present an application of the Canonical Maximum Likelihood Method (CML) for calibrating Student copula. The paper has several practical implications that are of value for financial hedgers and engineers, financial regulators, government regulators, central banks, and risk managers.