Replication,pricing And Hedging Of Counterparty Exposure Of Credit Linked Notes

In this paper,under the framework of the reduced model,we study replication,pricing,and hedging of credit linked notes(CLN).First of all,from the most simple CLN,that is not the case of counterparty risk.After the dynamic price process of CLN,we use bank deposits and CDS to build a portfolio.When at least 2 of the CDS in portfolio,there is a trading strategy to copy the CLN.Especially,when there are only 2 CDS,the trading strategy is the only one,and gives the trading strategy.Secondly,we consider the CLN pricing problem with counterparty risk.Under the Markov Copula model,we give the partial differential equation of CLN price.In particular,assuming that default intensity of the underlying assets satisfies the CIR model,when the default intensity of underlying assets and the default intensity of counterparty meet: positive correlation,negative correlation and between both positive and negative.The partial differential equation of the CLN price has a explicit solution and is used for the final numerical analysis.Finally,in the Markov Copula model,according to the CLN price dynamic process,we can calculate the dynamic process of the credit value adjustment.Then we use the rolling CDS hedge credit value adjustment of counterparty risk,and calculate the hedge ratio.