Pricing k th realization derivatives and collateralized debt obligation with multivariate Fréchet copula

Abstract

Copula method has been widely applied to model the correlation among underlying assets in financial market. In this paper, we propose to use the multivariate Frechet copula family presented in J. P. Yang et al. [Insurance Math. Econom., 2009, 45: 139–147] to price multivariate financial instruments whose payoffs depend on the kth realization of the underlying assets and collateralized debt obligation (CDO). The advantage of the multivariate Frechet copula is discussed. Empirical study shows that such copula family gives a better fitting to CDO’s market price than Gaussian copula for some derivatives.