Cyclical correlations, credit contagion, and portfolio losses
AbstractWe model aggregate credit losses on large portfolios of financial positions contracted with firms subject to both cyclical default correlation and direct default contagion processes. Cyclical correlation is due to the dependence of firms on common (macro-) economic factors; credit contagion phenomena are associated with the local interaction of firms with their business partners. We provide an explicit normal approximation of the distribution of total portfolio losses, which is the key to the measurement and management of aggregated credit loss risk. Based on this result we quantify the relation between the variability of global economic fundamentals, strength of local interaction between firms, and the fluctuation of portfolio losses. In particular, we find that cyclical oscillations in fundamentals dominate average portfolio losses, while local firm interaction and the associated contagion processes cause additional fluctuations of losses around their average. The strength of the contagion-induced loss variability and hence the degree of extreme loss risk depends on the complexity of the business partner network, a relation that was recently confirmed by empirical studies. --
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 Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes in its series SFB 373 Discussion Papers with number 2003,11.
Date of creation: 2003
Date of revision:
cyclical correlation; credit contagion; portfolio losses; voter model; Bernoulli mixture model;
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.:
- Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
- Siem Jan Koopman & Andr� Lucas, 2003. "Business and Default Cycles for Credit Risk," Tinbergen Institute Discussion Papers 03-062/2, Tinbergen Institute, revised 09 Jan 2003.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics).
If references are entirely missing, you can add them using this form.