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A Nonparametric Urn-Based Approach To Interacting Failing Systems With An Application To Credit Risk Modeling

Author

Listed:
  • PASQUALE CIRILLO

    (Institute of Mathematical Statistics and Actuarial Sciences, University of Bern, Sidlerstrasse 5, Bern, CH-3012, Switzerland)

  • JÜRG HÜSLER

    (Institute of Mathematical Statistics and Actuarial Sciences, University of Bern, Sidlerstrasse 5, Bern, CH-3012, Switzerland)

  • PIETRO MULIERE

    (Department of Decision Sciences, Bocconi University Via Röntgen 1, Milan, IT-20136, Italy)

Abstract

In this paper we propose a new nonparametric approach to interacting failing systems (FS), that is systems whose probability of failure is not negligible in a fixed time horizon, a typical example being firms and financial bonds. The main purpose when studying a FS is to calculate the probability of default and the distribution of the number of failures that may occur during the observation period. A model used to study a failing system is defined default model. In particular, we present a general recursive model constructed by the means of interacting urns. After introducing the theoretical model and its properties we show a first application to credit risk modeling, showing how to assess the idiosyncratic probability of default of an obligor and the joint probability of failure of a set of obligors in a portfolio of risks, that are divided into reliability classes.

Suggested Citation

  • Pasquale Cirillo & Jürg Hüsler & Pietro Muliere, 2010. "A Nonparametric Urn-Based Approach To Interacting Failing Systems With An Application To Credit Risk Modeling," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(08), pages 1223-1240.
    • Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:08:n:s0219024910006170
    DOI: 10.1142/S0219024910006170
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    Citations

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    Cited by:

    1. Cheng, Dan & Cirillo, Pasquale, 2018. "A reinforced urn process modeling of recovery rates and recovery times," Journal of Banking & Finance, Elsevier, vol. 96(C), pages 1-17.
    2. Pasquale Cirillo & Jürg Hüsler & Pietro Muliere, 2013. "Alarm Systems and Catastrophes from a Diverse Point of View," Methodology and Computing in Applied Probability, Springer, vol. 15(4), pages 821-839, December.
    3. Peluso, Stefano & Mira, Antonietta & Muliere, Pietro, 2015. "Reinforced urn processes for credit risk models," Journal of Econometrics, Elsevier, vol. 184(1), pages 1-12.

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