ZC tranche pricing

dej · June 11th, 2007, 12:01 pm

HI,I have calibrated the standard gaussian copula model on 10Y standard tranches prices and used the output (base correl curve) to calculate the 0-3% ZC price: I find a 10Y price which seems too low (I find around 2.5%-3% instead of something around 5%)Is my implementation wrong or is the 10Y maturity specific?ThanksDej

slym · June 11th, 2007, 4:52 pm

I'm not that surprised ... ZCE price is just the discounted remaining notional of the equity tranche ... As of end of may, I had a equity Exp. Loss of around 2.8% (out of 3%), thus undiscounted = 4,5% and when discounted roughly equals 2,5% ... but maybe I understood nothing to ZCE

dej · June 12th, 2007, 6:22 am

That's exactly the figures I have but I don't know why there is such a big difference between the quoted prices and the fair prices implied by the standard tranches...is the model used for ZC pricing different or is the hedge of this product difficult? Is there a link between this difference and the fact that a hedge for this tranche is a standard tranche and a IO (interst Only) tranche which is may be more difficult to find on the market?

guoted · June 13th, 2007, 6:51 pm

Based on my experience, you won't get dealer's ZC price if you price it using the base correlation implied from the standard tranche, and I believe that the impiled base corr from ZC is typically 20+% higher than that from the standard tranche. It'd be great if someone could offer some insight as to why that's the case... or would this base corr descrpency represents any arbitrage opportunity?Thanks