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Extending Credit Risk (Pricing) Models for the Simulation of Portfolios of Interest Rate and Credit Risk Sensitive Securities

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  • Norbert Jobst
  • Stavros A. Zenios

Abstract

We discuss extensions of intensity based models for pricing credit risk and derivative securities to the simulation and valuation of portfolios. The stochasticity in interest rates, credit spreads (default intensities) and rating migrations are incorporated in a unified framework. Scenarios of future prices of all securities are calculated in a risk-neutral world. The calculated prices are consistent with observed prices and the term structure of default free and defaultable interest rates. Three applications are discussed: (i) study of the inter-temporal price sensitivity of credit bonds to changes in interest rates, default probabilities, recovery rates and rating migration, (ii) portfolio simulations with attribution of changes to credit events and interest rates and, (iii) tracking of corporate bond indices. Key words: credit risk, default risk, simulation, integrated product management

Suggested Citation

  • Norbert Jobst & Stavros A. Zenios, 2001. "Extending Credit Risk (Pricing) Models for the Simulation of Portfolios of Interest Rate and Credit Risk Sensitive Securities," Center for Financial Institutions Working Papers 01-25, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Handle: RePEc:wop:pennin:01-25
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    File URL: http://fic.wharton.upenn.edu/fic/papers/01/0125.pdf
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    Cited by:

    1. Mathias Drehmann & Steffen Sorensen & Marco Stringa, 2007. "Integrating credit and interest rate risk: A theoretical framework and an application to banks' balance sheets," Money Macro and Finance (MMF) Research Group Conference 2006 151, Money Macro and Finance Research Group.
    2. Mathias Drehmann & Steffen Sorensen & Marco Stringa, 2008. "The integrated impact of credit and interest rate risk on banks: an economic value and capital adequacy perspective," Bank of England working papers 339, Bank of England.
    3. Sorge, Marco & Virolainen, Kimmo, 2006. "A comparative analysis of macro stress-testing methodologies with application to Finland," Journal of Financial Stability, Elsevier, vol. 2(2), pages 113-151, June.
    4. Colin Turfus, 2018. "Quantifying Correlation Uncertainty Risk in Credit Derivatives Pricing," IJFS, MDPI, vol. 6(2), pages 1-20, April.
    5. Norbert Jobst & Stavros A. Zenios, 2001. "The Tail that Wags the Dog: Integrating Credit Risk in Asset Portfolios," Center for Financial Institutions Working Papers 01-24, Wharton School Center for Financial Institutions, University of Pennsylvania.

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    More about this item

    Keywords

    credit risk; default risk; simulation; integrated product management;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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