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Monte Carlo simulation for CDO tranche pricing
Hi,Just a very basic question. For a monte carlo simulation to find out the par spread of a cdo tranche, do I average out the losses, get a expected loss and then calculate par spread, or calculate a large number of par spreads and average them out. Also, some explanation will be good too Thanks..
Monte Carlo simulation for CDO tranche pricing
you don't calculate the average first.. averaging is done afterwards, just like you don't calculate option price as Max(0 , S_terminal/n - strike)
Monte Carlo simulation for CDO tranche pricing
Yup. That's what I thought so too. However, if I compare the results of the 2 averaging methods with the Hull White's pricing of CDO without monte carlo or Gibson's paper, the averaging loss has a closer result as compared to the averaging of spreads method. This makes sense too as averaging the losses is like getting the expected losses, and then making use of the expected loss to calculate a par spread.