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Correlation Smile, Volatility Skew and Systematic Risk Sensitivity of Tranches.

Hamerle, Alfred ; Igl, Andreas ; Plank, Kilian


Abstract

The classical way of treating the correlation smile phenomenon with credit index tranches is to choose a sufficiently flexible model and fit it to tranche market prices. In this article we go a step further and try to explain the tranche prices more fundamentally without directly fitting them. To this end, we use a risk neutral measure of the market factor which we derive from equity index ...

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