The Improvement Of Synthetic CDO Pricing Method And Its Application In Credit Risk Management Of Commercial Banks In China

CDOs, i.e, collateralized debet obligations, the main underlying assets of which are commercial bank loans or bonds, are evolved by Asset-backed Securities. With the development of the credit derivatives market, there appears a great financial innovation, that is, Synthetic CDO, which is a combination of asset securitization and credit default swaps. The internal mechanism of Synthetic CDO is to achieve the purpose of transferring and dispersing the credit risk of the asset portfolio without changing the real ownership of it. Such significant advantages of Synthetic CDO make it launch a new way of thinking how to promote the credit risk management mode and level of the commercial banks in China.Although the rapid development of the CDO market was considered to be the role of the culprit for the outbreak of the global financial crisis in2008, the deep reason is that the real value of the CDOs was not able to be made accurate judgment. To be exact, the credit risk of the CDOs was underestimated, which caused butterfly effect. The current domestic and foreign research on CDOs pricing has been increasingly thorough and systematic. And there are different pricing models and extentions, but all of them have shortcomings. Most of the models are too complex, which has caused that they cannot be accepted by the practical applications. Therefore, this article has carried out the following work.Firstly, the key factors of the Synthetic CDO pricing model involve the probability of default, recovery rate, the discount factor, default correlation coefficient, payment frequency, the connection and separation point, etc. Because in the real financial markts, interest rates have the risk of uncertainty, it is necessary to consider interest rate risk when pricing the Synthetic CDOs. And stochastic interest rate is a kind of term structure taking the risk into consideration. Example analysis shows that the Synthetic CDO pricing method is better than the pricing model which only assumes the risk-free rate as a fixed constant. And the results also show that the interest rate volatility has obvious effects to the spread of Equity Tranches, of Mezzanine Tranches times, and the spread of Senior Tranches is hardly affected by interest fluctuations.Secondly, standard single factor Gaussian Copulas connecting the recovery rate assumed to be a constant is not conformity with the actual situation, so on the basis of taking the stochastic interest rate into consideration, the random recovery is introduced into the SCDO (Synthetic CDO) pricing model. Thirdly, the commercial banks of our country have to face seven major risks, among which credit risk is the most traditional and most important class of risk. So the application of Synthetic CDO is of great significance for improving the credit risk management model. In view of the financial system dominated by banks of our country, the author has designed the basic structure of three kinds of Synthetic CDO, which are used to improve the credit risk management level of various types of commercial bank in our country and to solve the financing problem of large, medium, and micro enterprises in China. If our country is going to develop Synthetic CDOs, though it will need to face some problems, it also has its potential advantages. When the time and conditions are right, Synthetic CDOs belonging to our country can appear.