CDO Pricing with Copulae

Modeling the portfolio credit risk is one of the crucial issues of the last yearsin the financial problems. We propose the valuation model of Collateralized DebtObligations based on a one- and two-parameter copula and default intensities estimatedfrom market data. The presented method is used to reproduce the spreadsof the iTraxx Europe tranches. The two-parameter model incorporates the factthat the risky assets of the CDO pool are chosen from six different industry sectors.The dependency among the assets from the same group is described with thehigher value of the copula parameter, otherwise the lower value of the parameter isascribed. Our approach outperforms the standard market pricing procedure basedon the Gaussian distribution.