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Tail Behavior of Credit Loss Distributions for General Latent Factor Models

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Author Info
André Lucas () (Vrije Universiteit Amsterdam)
Pieter Klaassen (ABN AMRO Bank NV)
Peter Spreij (University of Amsterdam)
Stefan Straetmans (Maastricht University)

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Abstract

Using a limiting approach to portfolio credit risk, we obtain analytic expressions for the tail behavior of the distribution of credit losses. We show that in many cases of practical interest the distribution of these losses has polynomial ('fat') rather than exponential ('thin') tails. Our modeling framework encompasses the models available in the literature. Defaults are triggered by a general latent factor model involving systematic and idiosyncratic risk. We show explicitly how the tail behavior of the distribution of these two risk factors relates to the tail behavior of the credit loss distribution. Even if the distributions of both risk factors are thin-tailed, the credit loss distribution may have a finite tail index (polynomial tails). If idiosyncratic risk exhibits thinner tails than systematic risk, the credit loss density actually increases towards the maximum credit loss. This unconventional behaviour of the credit loss density has not been reported earlier in the literature. We also derive analytically the interaction between portfolio quality and credit loss tail behavior and find a striking difference between two well-known modeling frameworks for portfolio credit risk: CreditMetrics and CreditRisk+.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 01-023/2.

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Date of creation: 26 Feb 2001
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Handle: RePEc:dgr:uvatin:20010023

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Web page: http://www.tinbergen.nl/

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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 listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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.). [Downloadable!]
  2. Laszlo Goerke, 1999. "The Wedge," IZA Discussion Papers 71, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
    • Goerke, Laszlo, 2000. "The Wedge," Manchester School, University of Manchester, vol. 68(5), pages 608-23, September. [Downloadable!] (restricted)
  3. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, 08. [Downloadable!] (restricted)
  4. 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. [Downloadable!]
    Other versions:
  5. 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. [Downloadable!] (restricted)
    Other versions:
  6. Howard J. Wall, 1999. "Help wanted," National Economic Trends, Federal Reserve Bank of St. Louis, issue May. [Downloadable!]
  7. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Hayette Gatfaoui, 2003. "How Does Systematic Risk Impact US Credit Spreads? A Copula Study," Risk and Insurance 0308002, EconWPA. [Downloadable!]
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