Pricing Equity and Debt Tranches of Collateralized Funds of Hedge Fund Obligations: an approach based on Stochastic Time Change and Esscher Transformed Martingale Measure

Tassinari, Gian Luca ; Corradi, Corrado (2011) Pricing Equity and Debt Tranches of Collateralized Funds of Hedge Fund Obligations: an approach based on Stochastic Time Change and Esscher Transformed Martingale Measure. [Preprint]
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Abstract

Collateralized Funds of Hedge Fund Obligations (CFOs) are relatively recent structured finance products linked to the performance of underlying funds of hedge funds. The capital structure of a CFO is similar to traditional Collateralized Debt Obligations (CDOs), meaning that investors are offered different rated notes and equity interest. CFOs are structured as arbitrage market value CDOs. The fund of funds manager actively manages the fund to maximize total return while limiting price volatility within the guidelines of the structure. The aim of this paper is to provide a useful framework to evaluate Collateralized Funds of Hedge Fund Obligations, that is pricing the equity and the debt tranches of a CFO. The basic idea is to evaluate each CFO liability as an option written on the underlying pool of hedge funds. The value of every tranche depends on the evolution of the collateral portfolio during the life of the contract. Care is taken to distinguish between the fund of hedge funds and its underlying hedge funds. The proposed model incorporates skewness, excess-kurtosis and is able to capture more complex dependence structures among hedge fund log-returns than the mere correlation matrix. With this model it is possible to describe the impact of an equivalent change of probability measure not only on the marginal processes but also on the underlying dependence structure among hedge funds.

Abstract
Document type
Preprint
Creators
CreatorsAffiliationORCID
Tassinari, Gian Luca
Corradi, Corrado
Keywords
Stochastic Time Change, Multivariate Variance Gamma Process, Multivariate Esscher Transform, Risk Neutral Dynamics
Subjects
DOI
Deposit date
13 Apr 2012 07:29
Last modified
11 May 2012 10:54
URI

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