Study of pricing models for credit linked-nots (CLN)

Abstract

1) Introduction and context description:

CLNs are extremely interesting structured derivatives. The pricing of CLNs was done through two methods -the creditmetrics approach and the Gaussian copula method. Also the relevance of CLNs in India and its application along with difference with CDS was studied.

2) Research questions:

To understand the fundamental difference between CLN and CDS To study and understand the pricing techniques of CLNs. A comparative study between the two techniques -Gaussian Copula approach and Credit Metrics Approach. To study the scope of CLNs in the Indian market.

3) Methodology:

A portfolio was selected and the relevant data would gathered frola CRISIL and Bloomberg website. Of the various techniques available, we focused on the Gaussian Copula and the Credit Metrics approach Excel executable tools was developed and compared the two models in Pricing of Credit Linked Notes

4) Findings:

The two methods gave similar spread except for the Monte Carlo siniulation error.

5) Limitations of the study:

The pricing sheets cannot be used for bonds from issuers for which rating data is not available, or when the portfolio consists of bonds from issuers for which credit rating from the same rating agency is not available. The latter is expecially relevant in the Indian context. Corporate bond markets in India are not very well developed, so spre'lils obtaincti by using data related to their prices and yields may not be accurate

6) Scope for further work:

The model is developed on excel. For larger number of assets an( for hiyher number of monte Carlo simulations, some other platform would be more appropriate and sturdy. Further study required to study rating methods from different agencies, so that a method across rating agencies can be developed

7) Key words (upto five): CLNs, Credit metrics, Gaussian Coupla, Monte Carlo simulation, CLN is India