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Tail behaviour of credit loss distributions for general latent factor models

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Author Info

  • Andre Lucas
  • Pieter Klaassen
  • Peter Spreij
  • Stefan Straetmans

Abstract

Using a limiting approach to portfolio credit risk, we obtain analytic expressions for the tail behavior of credit losses. To capture the co-movements in defaults over time, we assume that defaults are triggered by a general, possibly non-linear, factor model involving both systematic and idiosyncratic risk factors. The model encompasses default mechanisms in popular models of portfolio credit risk, such as CreditMetrics and CreditRisk+. We show how the tail characteristics of portfolio credit losses depend directly upon the factor model's functional form and the tail properties of the model's risk factors. In many cases the credit loss distribution has a polynomial (rather than exponential) tail. This feature is robust to changes in tail characteristics of the underlying risk factors. Finally, we show that the interaction between portfolio quality and credit loss tail behavior is strikingly different between the CreditMetrics and CreditRisk+ approach to modeling portfolio credit risk.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

Volume (Year): 10 (2003)
Issue (Month): 4 ()
Pages: 337-357

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Handle: RePEc:taf:apmtfi:v:10:y:2003:i:4:p:337-357

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Related research

Keywords: portfolio credit risk; extreme value theory; tail events; tail index; factor models; economic capital; portfolio quality; second-order expansions;

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References

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  1. Anil Bangia & Francis X. Diebold & Til Schuermann, 2000. "Ratings Migration and the Business Cycle, With Application to Credit Portfolio Stress Testing," Center for Financial Institutions Working Papers 00-26, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, 08.
  3. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
  4. Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001. "An analytic approach to credit risk of large corporate bond and loan portfolios," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1635-1664, September.
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Cited by:
  1. Mehari Mekonnen Akalu, 2002. "Measuring and Ranking Value Drivers," Tinbergen Institute Discussion Papers 02-043/2, Tinbergen Institute.
  2. Hayette Gatfaoui, 2010. "Investigating the dependence structure between credit default swap spreads and the U.S. financial market," Annals of Finance, Springer, vol. 6(4), pages 511-535, October.
  3. Bologov , Yaroslav, 2013. "A copula-based approach to portfolio credit risk modeling," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 29(1), pages 45-66.
  4. Hayette Gatfaoui, 2003. "How Does Systematic Risk Impact US Credit Spreads? A Copula Study," Risk and Insurance 0308002, EconWPA.

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