The pricing of portfolio credit risk
AbstractEquity and credit-default-swap (CDS) markets are in disagreement as to the extent to which asset returns co-move across firms. This suggests market segmentation and casts ambiguity about the asset-return correlations underpinning observed prices of portfolio credit risk. The ambiguity could be eliminated by – currently unavailable – data that reveal the market valuation of low-probability/large-impact events. At present, judicious assumptions about this valuation can be used to reconcile observed prices with asset-return correlations implied by either equity or CDS markets. These conclusions are based on an analysis of tranche spreads of a popular CDS index, which incorporate a rather small premium for correlation risk.
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Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 214.
Length: 39 pages
Date of creation: Sep 2006
Date of revision:
CDS index tranche; joint distribution of asset returns; correlation risk premium; copula;
Find related papers by JEL classification:
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-06-18 (All new papers)
- NEP-FMK-2007-06-18 (Financial Markets)
- NEP-RMG-2007-06-18 (Risk Management)
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