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Default correlation: an analytical result

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  • Chunsheng Zhou
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    Abstract

    Evaluating default correlations and the probabilities of multiple defaults is an important task in credit analysis and risk management, but it has never been an easy one because default correlations cannot be measured directly. This paper provides, for the first time, an analytical formula for calculating default correlations based on a first-passage-time model that can be easily implemented and conveniently used in a variety of financial applications. This paper also provides a theoretical justification for many empirical results found in the literature and increases our understanding of the important features of default correlations.

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    File URL: http://www.federalreserve.gov/pubs/feds/1997/199727/199727abs.html
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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1997-27.

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    Date of creation: 1997
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    Handle: RePEc:fip:fedgfe:1997-27

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    Related research

    Keywords: Credit ; Debt ; Risk;

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    Cited by:
    1. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
    2. Carey, Mark, 2002. "A guide to choosing absolute bank capital requirements," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 929-951, May.
    3. Cowan, Adrian M. & Cowan, Charles D., 2004. "Default correlation: An empirical investigation of a subprime lender," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 753-771, April.
    4. Mark Carey, 2000. "Dimensions of Credit Risk and Their Relationship to Economic Capital Requirements," NBER Working Papers 7629, National Bureau of Economic Research, Inc.
    5. Battiston, Stefano & Delli Gatti, Domenico & Gallegati, Mauro & Greenwald, Bruce & Stiglitz, Joseph E., 2012. "Liaisons dangereuses: Increasing connectivity, risk sharing, and systemic risk," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1121-1141.
    6. Dermine, Jean & Lajeri, Fatma, 2001. "Credit risk and the deposit insurance premium: a note," Journal of Economics and Business, Elsevier, vol. 53(5), pages 497-508.
    7. Mark Carey & Mark Hrycay, 2000. "Parameterizing credit risk models with rating data," Finance and Economics Discussion Series 2000-47, Board of Governors of the Federal Reserve System (U.S.).
    8. Lucas, André & Klaassen, Pieter & Spreij, Peter, 1999. "An analytic approach to credit risk of large corporate bond and loan portfolios," Serie Research Memoranda 0018, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
    9. Bandyopadhyay, Arindam, 2010. "Understanding the Effect of Concentration Risk in the Banks’ Credit Portfolio: Indian Cases," MPRA Paper 24822, University Library of Munich, Germany.
    10. Jones, David & Mingo, John, 1999. "Credit risk modeling and internal capital allocation processes: implications for a models-based regulatory bank capital standard," Journal of Economics and Business, Elsevier, vol. 51(2), pages 79-108, March.
    11. Mark Carey, 2000. "Dimensions of credit risk and their relationship to economic capital requirements," Finance and Economics Discussion Series 2000-18, Board of Governors of the Federal Reserve System (U.S.).
    12. Palombini, Edgardo, 2009. "Factor models and the credit risk of a loan portfolio," MPRA Paper 20107, University Library of Munich, Germany.
    13. Mark Carey, 2002. "A guide to choosing absolute bank capital requirements," International Finance Discussion Papers 726, Board of Governors of the Federal Reserve System (U.S.).

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