The 2007–2009 Financial Crisis and Credit Derivatives

  • Mmboniseni Mulaudzi
  • Mark Petersen
  • Janine Mukuddem-Petersen
Conference paper


We discuss the relationship between investor payoffs and credit derivatives such as credit default swaps (CDSs) and mortgage-related collateralized debt obligations (CDOs). In this regard, we investigate the role that the interplay between these components played in the global financial crisis (GFC). More specifically, we develop a stochastic model for investor payoffs from investment in CDO tranches that are protected by CDSs. In a continuous-time framework, this model enables us to solve a stochastic optimal credit default insurance problem that has investor consumption and investment in structured mortgage products as controls. Finally, we provide numerical results involving mezzanine CDO tranches being hedged by CDSs and explain their link with the GFC.


Collateralized debt obligation Credit default swap Credit derivatives Credit risk Global financial crisis Systemic risk 


  1. 1.
    K.J. Arrow, Uncertainty and the welfare economics of medical care. Am. Econ. Rev. 53, 941–973 (1963)Google Scholar
  2. 2.
    Y. Demyanyk, O. Van Hemert, Understanding the subprime mortgage crisis. Available at SSRN: Accessed 19 Aug 2008
  3. 3.
    Y. Deng, S.A. Gabriel, A.B. Sanders, CDO market implosion and the pricing of subprime mortgage-backed securities. J. Hous. Econ. 20(2), 68–80 (2011)CrossRefGoogle Scholar
  4. 4.
    F.J. Fabozzi, X. Cheng, R.-R. Chen, Exploring the components of credit risk in credit default swaps. Finance Res. Lett. 4, 10–18 (2007)CrossRefGoogle Scholar
  5. 5.
    C.H. Fouche, J. Mukuddem-Petersen, M.A. Petersen, M.C. Senosi, Bank valuation and its connections with the subprime mortgage crisis and basel II capital accord. Discrete Dynam. Nat. Soc. 44 (2008). doi: 10.1155/2008/740845
  6. 6.
    J. Hull, M. Predescu, A. White, The relationship between credit default swap spreads, bond yields and credit rating announcements. J. Bank. Finance 28, 2789–2811 (2004)CrossRefGoogle Scholar
  7. 7.
    J.B. Kau, D.C. Keenan, C. Lyubimov, V.C. Slawson, Subprime mortgage default. J. Urban Econ. 70, 75–87 (2011)CrossRefGoogle Scholar
  8. 8.
    K. Kendra, Tranche ABX and basis risk in subprime RMBS structured portfolios, Bloomberg, Accessed 20 Feb 2007
  9. 9.
    K.S. Moore, V.R. Young, Optimal insurance in a continuous-time model. Insur. Math. Econ 39, 47–68 (2006)CrossRefMATHMathSciNetGoogle Scholar
  10. 10.
    M.P. Mulaudzi, M.A. Petersen, J. Mukuddem-Petersen, Credit derivatives and global financial crisis. Lecture Notes in Engineering and Computer Sciences: Proceedings of the World Congress on Engineering and Computer Sciences 2013, WCECS 2013, 23–25 October, 2013. San Frascisco, USA, pp 925–930 (2013)Google Scholar
  11. 11.
    J.P. Morgan, Credit Derivatives Handbook: Detailing Credit Default Swap Products, Markets and Trading Strategies (JPMorgan Corporate Quantitative Research, New York, 2006)Google Scholar
  12. 12.
    M.A. Petersen, M.P. Mulaudzi, I.M. Schoeman, J. Mukuddem-Petersen, A note on the subprime mortgage crisis: dynamic modeling of bank leverage profit under loan securitization. Appl. Econ. Lett. 17(15), 1469–1474 (2009)CrossRefGoogle Scholar
  13. 13.
    M.A. Petersen, M.C. Senosi, J. Mukuddem-Petersen, Subprime Mortgage Models. (Nova Science Publishers, New York, 2010) (ISBN: 978-1-61761-132-2 (ebook); ISBN: 978-1-61728-694-0 (Hardcover) 2011)Google Scholar
  14. 14.
    P. Protter, Stochastic Integration and Differential Equations, 2nd edn. (Springer, Berlin, 2004)MATHGoogle Scholar
  15. 15.
    H.M. Soner, W.H. Fleming, Controlled Markov Processes and Viscosity Solutions, 2nd edn. (Springer, New York, 2008)Google Scholar

Copyright information

© Springer Science+Business Media Dordrecht 2014

Authors and Affiliations

  • Mmboniseni Mulaudzi
    • 1
  • Mark Petersen
    • 2
  • Janine Mukuddem-Petersen
    • 2
  1. 1.Department of Decision SciencesUniversity of South AfricaPretoriaSouth Africa
  2. 2.Faculty of Commerce and AdministrationNorth West UniversityMmabathoSouth Africa

Personalised recommendations