Analytical Solution for the Loss Distribution of a Collateralized Loan under a Quadratic Gaussian Default Intensity Process
AbstractIn this study, we derive an analytical solution for expected loss and the higher moment of the discounted loss distribution for a collateralized loan. To ensure nonnegative values for intensity and interest rate, we assume a quadratic Gaussian process for default intensity and discount interest rate. Correlations among default intensity, discount interest rate, and collateral value are represented by correlations among Brownian motions driving the movement of the Gaussian state variables. Given these assumptions, the expected loss or the m-th moment of the loss distribution is obtained by a time integral of an exponential quadratic form of the state variables. The coefficients of the form are derived by solving ordinary differential equations. In particular, with no correlation between default intensity and discount interest rate, the coefficients have explicit closed form solutions. We show numerical examples to analyze the effects of the correlation between default intensity and collateral value on expected loss and the standard deviation of the loss distribution.
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 Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 11-E-20.
Date of creation: Sep 2011
Date of revision:
Contact details of provider:
Postal: 2-1-1 Nihonbashi, Hongoku-cho, Chuo-ku, Tokyo 103
Web page: http://www.imes.boj.or.jp/
More information through EDIRC
default intensity; stochastic recovery; quadratic Gaussian; expected loss; measure change;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-10-01 (All new papers)
- NEP-BAN-2011-10-01 (Banking)
- NEP-RMG-2011-10-01 (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.:
- Li Chen & H. Vincent Poor, 2003. "Markovian Quadratic Term Structure Models For Risk-free And Defaultable Rates," Finance, EconWPA 0303008, EconWPA.
- Markus Leippold & Liuren Wu, 2002. "Design and Estimation of Quadratic Term Structure Models," Finance, EconWPA 0207014, EconWPA.
- Dong-Hyun Ahn & Robert F. Dittmar, 2002. "Quadratic Term Structure Models: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(1), pages 243-288, March.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kinken).
If references are entirely missing, you can add them using this form.