How correlation risk in basket credit derivatives might be priced and managed?

Dong-Mei Zhu*, Jia-wen Gu, Feng-Hui Yu, Wai-Ki Ching, Tak-Kuen Siu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review


In this paper, we construct quantitative models in which the dependence structure of the firms’ default times is incorporated. Such models serve as the underlying frameworks in our proposed approach to price and hedge basket credit derivatives. Through the Gaussian copula-based method, we model the default correlation risk and develop valuation formulas for credit derivatives. Using single-name derivatives in a hedging strategy for basket credit derivatives, the utility of the delta and delta-gamma hedging techniques are examined. This enables the management of risk attributed to the changes in correlation without the need for a large number of hedging instruments. Our research contributions provide insights on how dependent risks in basket credit derivatives could be dealt with effectively.
Original languageEnglish
Pages (from-to)195–219
Number of pages25
JournalIMA Journal of Management Mathematics
Issue number2
Publication statusPublished - Apr 2021


  • hedging
  • pricing
  • Gaussian copula models
  • basket credit default swaps


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