!A Primer for the Mathematics of Financial Engineering- Stefanica- 67 almost alm ost !

An intro to math of financial derivatives- Neftci- 20 almost almost A probability path- 170+ later capinski- measure integral probability- later Credit Models and the Crisis- Brigo- later Intro to Stochastic Calculus with Applications- 26 almost Structured finance and CDOs- Tavakoi- background only Credit Derivatives- A Primer on Credit Risk, Modeling, and Instruments- 79 later Copula Methods in Finance- 34- almost Modelling Single-Name and Multi-name Credit Derivatives- background !The Mathematics of Financial Modeling and Investment Management- 207 almostalmo st A Course in Financial Calculas- later Shreve- 23- almost !The Volatility Surface!!!!!________________________________________________________________________________ ________________ 3 parts: 1. Default Dependence Model 2. Credit Risk Modelling 3. Pricing Credit Derives(CDO+CDS) Ways to measure correlation (not dependence?): !1. Heston 1993- Brownian Motion-Stochastic correlation (bottom up)!!! 2. Copulas- Skylar 1959, Li 2000->extended Hull 2005, Burtschell 2007 CID Condit ionally Independent Correlation Modelling 3. Contagion Modeling- David+Lo 2001, Jarrow+Yu 2001 4. Top Down Approach- Schonbucher 2006(markov), Kuznetsov 2006, Giesecke and Tom ecek 2005, Giesceke 2009 (credit contagion) ________________________________________________________________________________ __ Point of the paper: Use some type of Brownian motion (if possible, nonnormal) to find stochastic correlation and then (maybe plug it into the Gaussian [or DYNAMIC??]copula or a better fit copula) us e it to model default dependence (ACTUALLY OR JUST END IT THERE BECAUSE THE POINT OF THE PAPER IS TO 1. Do BrOWNI AN mOTION STOCHASTIC CORRELATION=DEPENDENCE. BUT HOW TO PREDICT DEFAULT TIME/PROBABILITY?? ornstein uhlenback. Jacobi process can also model stochastic correlation. Tranches (groups of mortgages/bonds/loans) correlation vs company correlation. Sklar's theorem= a model (copula) can be constructed from marginal probs to form joint probs. So by picking a better copula (for connecting indivitual stochastic correlation to a single aggregate multivariate model) and using stochastic correlation-->fixed? Extension: correlation smile/smirks to be implemented in copulas. Basically, imp lied correlation<-->stochastic correlation Extension: Extreme Value Theory Stochastic Correlation through simulations? -->convert to Kendall's Tau-->copula -->calibrate-->? Asset correlation shows two typical stylized features: Correlation clustering: periods of high (low) correlation are likely to be followed by periods

of high (low) correlation. Asymmetry and co-movement with volatility: high volatility in falling markets goes hand in hand with a strong increase in correlation, but this is not the case for rising markets, see [12] or [1]. Important: Asset vs default correlation!

________________________________________________________________________________ ___ Best paper: http://mfe.shidler.hawaii.edu/downloads/Asset_Modeling_Stochastic_Vo latiltiy_and_Stochastic_Correlation.pdf ^applying that to default while extending the model for jumps. No copulas! http://www.risk.net/digital_assets/4221/v11n3a2.pdf (modelling correlated defaul ts:first passage model under stochastic vol) ^the model--> I can apply it by pricing CDO's by taking in account of (stochasti c?) recovery rate http://www.math.mcmaster.ca/tom/IJTAF_1208_P1213.pdf (Credit Risk Modeling Using Time-Changed Brownian Motion) Time changed Brownian Motion- uses to model firm's asset value process and time of default. NOT correlation.He does go on Levy processes and jump processes. http://www.cer.ethz.ch/research/WP-10-131.pdf (Default Risk in Stochastic Volati lity Models) Extends Merton+stochastic volatility model- BUT again for default prob and NOT C orrelation http://www-num.math.uni-wuppertal.de/fileadmin/mathe/www-num/preprints/amna_06_0

3.pdf (Modeling Correlation as Stochastic...) Best paper on Stochastic Correlation Models. http://www.thisisthegreenroom.com/2009/deconstructing-the-gaussian-copula-part-i ii/ Main problems with the Gaussian Copula ________________________________________________________________________ So you know (default) correlation is usually modeled with lots and lots of copul as. Even now people still use them but with "corrections." So, I thought of an a lternative, to use some kind of Brownian Motion to model "stochastic correlation ." But for some reason, people only 1. model stochastic volatility for default p rob, 2. model stochastic correlation for the stock market trying to beat the eff icient market hypothesis. For some odd reason, no one modeled stochastic correla tion of defaults. I can't tell if 1. wow no one has thought of this or 2. people have thought of i t but gave up b/c it's a dead-end or 3. people have went past it and everyone al ready know it. For some reason, I feel like stochastic correlation would fix most of the proble m of the original Gaussian copula.

________________________________________________________________________________ ____________________ 3 Measures of dependence: linear correlation, rank correlation(spearmans rho,ken dalls tau),coefficients of tail dependence. Problems with Gaussian copula: 1.no fat tails 2.unable to fit the market prices without tweaks (base correlation) which make t he model arbitrageable 3.static model 4. no tail dependence Stochastic correlation! vs quotient correlation? vs local Gaussian correlation m odel!! vs vs applying stochastic volatility to correlation vs alternative measures of depe ndence. What is random factor loading model-->dead.