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Credit risk assessment of fixed income portfolios using explicit expressions

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  • Pagnoncelli, Bernardo K.
  • Cifuentes, Arturo

Abstract

We propose a model to assess the credit risk features of fixed income portfolios assuming they can be characterized by two parameters: their default probability and their default correlation. We rely on explicit expressions to assess their credit risk and demonstrate the benefits of our approach in a complex leveraged structure example. We show that using expected loss as a proxy for credit risk is misleading as it does not capture the dispersion effects introduced by correlation. The implications of these findings are relevant for improving current risk management practices and for regulation purposes.

Suggested Citation

  • Pagnoncelli, Bernardo K. & Cifuentes, Arturo, 2014. "Credit risk assessment of fixed income portfolios using explicit expressions," Finance Research Letters, Elsevier, vol. 11(3), pages 224-230.
    • Handle: RePEc:eee:finlet:v:11:y:2014:i:3:p:224-230
    DOI: 10.1016/j.frl.2014.02.007
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    References listed on IDEAS

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    1. Francis A. Longstaff & Arvind Rajan, 2008. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," Journal of Finance, American Finance Association, vol. 63(2), pages 529-563, April.
    2. Joshua Coval & Jakub Jurek & Erik Stafford, 2009. "The Economics of Structured Finance," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 3-25, Winter.
    3. Ingo Fender & John Kiff, 2004. "CDO rating methodology: Some thoughts on model risk and its implications," BIS Working Papers 163, Bank for International Settlements.
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    Cited by:

    1. Changqing Luo & Mengzhen Li & Zisheng Ouyang, 2016. "An empirical study on the correlation structure of credit spreads based on the dynamic and pair copula functions," China Finance Review International, Emerald Group Publishing Limited, vol. 6(3), pages 284-303, August.

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    More about this item

    Keywords

    Credit risk; Expected loss; Correlation;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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