An extension of Davis and Lo's contagion model
AbstractThe present paper provides a multi-period contagion model in the credit risk field. Our model is an extension of Davis and Lo's infectious default model. We consider an economy of n firms which may default directly or may be infected by other defaulting firms (a domino effect being also possible). The spontaneous default without external influence and the infections are described by not necessarily independent Bernoulli-type random variables. Moreover, several contaminations could be required to infect another firm. In this paper we compute the probability distribution function of the total number of defaults in a dependency context. We also give a simple recursive algorithm to compute this distribution in an exchangeability context. Numerical applications illustrate the impact of exchangeability among direct defaults and among contaminations, on different indicators calculated from the law of the total number of defaults. We then examine the calibration of the model on iTraxx data before and during the crisis. The dynamic feature together with the contagion effect seem to have a significant impact on the model performance, especially during the recent distressed period.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by HAL in its series Post-Print with number hal-00374367.
Date of creation: 2013
Date of revision:
Publication status: Published, Quantitative Finance, 2013, 13, 3, 407-420
Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00374367
Contact details of provider:
Web page: http://hal.archives-ouvertes.fr/
credit risk; contagion model; dependent defaults; default distribution; exchangeability; CDO tranches;
Other versions of this item:
- NEP-ALL-2013-06-30 (All new papers)
- NEP-BAN-2013-06-30 (Banking)
- NEP-RMG-2013-06-30 (Risk Management)
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.:
- Friedel Epple & Sam Morgan & Lutz Schloegl, 2007. "Joint Distributions Of Portfolio Losses And Exotic Portfolio Products," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(04), pages 733-748.
- Philippe Jorion & Gaiyan Zhang, 2010. "Information Transfer Effects of Bond Rating Downgrades," The Financial Review, Eastern Finance Association, vol. 45(3), pages 683-706, 08.
- Denuit, Michel & Lefevre, Claude & Utev, Sergey, 2002. "Measuring the impact of dependence between claims occurrences," Insurance: Mathematics and Economics, Elsevier, vol. 30(1), pages 1-19, February.
- Egloff, Daniel & Leippold, Markus & Vanini, Paolo, 2007. "A simple model of credit contagion," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2475-2492, August.
- Rüdiger Frey & Jochen Backhaus, 2008. "Pricing And Hedging Of Portfolio Credit Derivatives With Interacting Default Intensities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(06), pages 611-634.
- Boissay, Frédéric, 2006. "Credit chains and the propagation of financial distress," Working Paper Series 0573, European Central Bank.
- Sanjiv R. Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2007.
"Common Failings: How Corporate Defaults Are Correlated,"
Journal of Finance,
American Finance Association, vol. 62(1), pages 93-117, 02.
- Sanjiv Das & Darrell Duffie & Nikunj Kapadia & Leandro Saita, 2006. "Common Failings: How Corporate Defaults are Correlated," NBER Working Papers 11961, National Bureau of Economic Research, Inc.
- Jorion, Philippe & Zhang, Gaiyan, 2007. "Good and bad credit contagion: Evidence from credit default swaps," Journal of Financial Economics, Elsevier, vol. 84(3), pages 860-883, June.
- Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
- M. Davis & V. Lo, 2001. "Infectious defaults," Quantitative Finance, Taylor & Francis Journals, vol. 1(4), pages 382-387.
- Herbertsson, Alexander, 2007. "Pricing Synthetic CDO Tranches in a Model with Default Contagion Using the Matrix-Analytic Approach," Working Papers in Economics 270, University of Gothenburg, Department of Economics.
- Fan Yu, 2007. "Correlated Defaults In Intensity-Based Models," Mathematical Finance, Wiley Blackwell, vol. 17(2), pages 155-173.
- Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December.
- Denuit, Michel & Dhaene, Jan & Ribas, Carmen, 2001. "Does positive dependence between individual risks increase stop-loss premiums?," Insurance: Mathematics and Economics, Elsevier, vol. 28(3), pages 305-308, June.
- Stéphane Loisel & Pierre Arnal & Romain Durand, 2010. "Correlation crises in insurance and finance, and the need for dynamic risk maps in ORSA," Working Papers hal-00502848, HAL.
- Patrick Gagliardini & Christian Gouriéroux, 2012. "Correlated Risks vs Contagion in Stochastic Transition Models," Working Papers 2012-07, Centre de Recherche en Economie et Statistique.
- Gagliardini, Patrick & Gouriéroux, Christian, 2013. "Correlated risks vs contagion in stochastic transition models," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2241-2269.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (CCSD).
If references are entirely missing, you can add them using this form.