medium · FRM Part 2 Credit Risk
In the context of the Gaussian copula to the Student-t copula for modeling joint defaults in a collateralized debt obligation (CDO) tranche.
If the pairwise asset correlation is fixed at 0.30, which copula will likely lead to a higher price for the senior protection (i.e., a higher probability of joint catastrophic losses)?
- Both will provide identical results because the pairwise correlation is the same.
- The Gaussian copula, because it assumes normally distributed asset returns.
- The Gaussian copula, if the number of names in the CDO is very large.
- The Student-t copula, because it exhibits non-zero lower tail dependence.
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