Dynamic replication of CDS tranche?

davidwhitaker · May 25th, 2005, 8:13 pm

Is it possible to construct a self-financing dynamic replicating portfolio for a tranche (say, 3%-7%) of a CDS index (like the CDX inv grade)? I know you can hedge the delta of the tranche at any point in time by holding the appropriate amount of the index, but is a 'riskless' dynamic portfolio possible, the same way that it (theoretically) is possible to replicate a plain vanilla stock option with the stock and a treasury bond? Thanks for any thoughts.

Ri · May 25th, 2005, 9:41 pm

nopeif you hedge spread risk, you don't hedge jump to default and the reverse