IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v11y2014i2p131-139.html
   My bibliography  Save this article

Contagion effect on bond portfolio risk measures in a hybrid credit risk model

Author

Listed:
  • Boudreault, Mathieu
  • Gauthier, Geneviève
  • Thomassin, Tommy

Abstract

This paper illustrates how modelling the contagion effect among assets of a given bond portfolio changes the risk perception associated to it. This empirical work is developed in a hybrid credit risk framework that incorporates recovery rate risk. Dependence structures among firms and between external shocks affecting firms together are considered. The presence of correlations among firm leverage ratios and the interrelation between default probabilities and recovery rates produces clusters of defaults with low recovery rates. This has a major impact on standard risk measures such as Value-at-Risk and conditional tail expectation. Consequently, an appropriate measurement of the contagion has a tremendous effect on the capital requirement of many financial institutions.

Suggested Citation

  • Boudreault, Mathieu & Gauthier, Geneviève & Thomassin, Tommy, 2014. "Contagion effect on bond portfolio risk measures in a hybrid credit risk model," Finance Research Letters, Elsevier, vol. 11(2), pages 131-139.
    • Handle: RePEc:eee:finlet:v:11:y:2014:i:2:p:131-139
    DOI: 10.1016/j.frl.2013.07.005
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544612313000378
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.frl.2013.07.005?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Umut Çetin & Robert Jarrow & Philip Protter & Yildiray Yildirim, 2008. "Modeling Credit Risk With Partial Information," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 23, pages 579-590, World Scientific Publishing Co. Pte. Ltd..
    2. Edward Altman & Andrea Resti & Andrea Sironi, 2004. "Default Recovery Rates in Credit Risk Modelling: A Review of the Literature and Empirical Evidence," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(2), pages 183-208, July.
    3. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
    4. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    5. Madan, Dilip & Unal, Haluk, 2000. "A Two-Factor Hazard Rate Model for Pricing Risky Debt and the Term Structure of Credit Spreads," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(1), pages 43-65, March.
    6. Gurdip Bakshi & Dilip Madan & Frank Xiaoling Zhang, 2006. "Investigating the Role of Systematic and Firm-Specific Factors in Default Risk: Lessons from Empirically Evaluating Credit Risk Models," The Journal of Business, University of Chicago Press, vol. 79(4), pages 1955-1988, July.
    7. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409, World Scientific Publishing Co. Pte. Ltd..
    8. Giesecke, Kay, 2004. "Correlated default with incomplete information," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1521-1545, July.
    9. Jean-Paul Laurent & Jon Gregory, 2005. "Basket default swaps, CDOs and factor copulas," Post-Print hal-03679517, HAL.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Shi, Baofeng & Zhao, Xue & Wu, Bi & Dong, Yizhe, 2019. "Credit rating and microfinance lending decisions based on loss given default (LGD)," Finance Research Letters, Elsevier, vol. 30(C), pages 124-129.
    2. Lumengo Bonga-Bonga & Tebogo Maake, 2021. "The Relationship between Carry Trade and Asset Markets in South Africa," JRFM, MDPI, vol. 14(7), pages 1-13, July.
    3. Cho, Yongbok & Lee, Yongwoong, 2022. "Asymmetric asset correlation in credit portfolios," Finance Research Letters, Elsevier, vol. 49(C).
    4. Gechun Liang & Xingchun Wang, 2021. "Pricing vulnerable options in a hybrid credit risk model driven by Heston–Nandi GARCH processes," Review of Derivatives Research, Springer, vol. 24(1), pages 1-30, April.
    5. Boudreault, Mathieu & Gauthier, Geneviève & Thomassin, Tommy, 2015. "Estimation of correlations in portfolio credit risk models based on noisy security prices," Journal of Economic Dynamics and Control, Elsevier, vol. 61(C), pages 334-349.
    6. Liu, Chih-Liang & Yang, Hsin-Feng, 2017. "Systemic risk in carry-trade portfolios," Finance Research Letters, Elsevier, vol. 20(C), pages 40-46.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2011.
    2. Jose Giancarlo Gasha & Mr. Andre O Santos & Mr. Jorge A Chan-Lau & Mr. Carlos I. Medeiros & Mr. Marcos R Souto & Christian Capuano, 2009. "Recent Advances in Credit Risk Modeling," IMF Working Papers 2009/162, International Monetary Fund.
    3. Gregory Connor & Lisa R. Goldberg & Robert A. Korajczyk, 2010. "Portfolio Risk Analysis," Economics Books, Princeton University Press, edition 1, number 9224.
    4. Chava, Sudheer & Jarrow, Robert, 2008. "Modeling loan commitments," Finance Research Letters, Elsevier, vol. 5(1), pages 11-20, March.
    5. Nystrom, Kaj & Skoglund, Jimmy, 2006. "A credit risk model for large dimensional portfolios with application to economic capital," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2163-2197, August.
    6. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 5, July-Dece.
    7. Xiao, Tim, 2018. "The Valuation of Credit Default Swap with Counterparty Risk and Collateralization," EconStor Preprints 203447, ZBW - Leibniz Information Centre for Economics.
    8. Xiao,Tim, 2018. "Pricing Financial Derivatives Subject to Multilateral Credit Risk and Collateralization," EconStor Preprints 202075, ZBW - Leibniz Information Centre for Economics.
    9. Yildirim, Yildiray, 2006. "Modeling default risk: A new structural approach," Finance Research Letters, Elsevier, vol. 3(3), pages 165-172, September.
    10. Alan White, 2018. "Pricing Credit Default Swap Subject to Counterparty Risk and Collateralization," Working Papers hal-01739310, HAL.
    11. Leonard Tchuindjo, 2007. "Pricing of Multi-Defaultable Bonds with a Two-Correlated-Factor Hull-White Model," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(1), pages 19-39.
    12. Xiao, Tim, 2013. "The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling," MPRA Paper 47136, University Library of Munich, Germany.
    13. Jarrow, Robert & Li, Haitao & Liu, Sheen & Wu, Chunchi, 2010. "Reduced-form valuation of callable corporate bonds: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 95(2), pages 227-248, February.
    14. Çetin, Umut, 2012. "On absolutely continuous compensators and nonlinear filtering equations in default risk models," Stochastic Processes and their Applications, Elsevier, vol. 122(11), pages 3619-3647.
    15. Kris Jacobs & Xiaofei Li, 2008. "Modeling the Dynamics of Credit Spreads with Stochastic Volatility," Management Science, INFORMS, vol. 54(6), pages 1176-1188, June.
    16. Tahir Choulli & Catherine Daveloose & Michèle Vanmaele, 2020. "A martingale representation theorem and valuation of defaultable securities," Mathematical Finance, Wiley Blackwell, vol. 30(4), pages 1527-1564, October.
    17. Tim, Xiao, 2019. "Pricing Credit Default Swap Subject to Counterparty Risk and Collateralization," MPRA Paper 94701, University Library of Munich, Germany.
    18. Murphy, Austin & Headley, Adrian, 2022. "An empirical evaluation of alternative fundamental models of credit spreads," International Review of Financial Analysis, Elsevier, vol. 81(C).
    19. Nan Chen & S. G. Kou, 2009. "Credit Spreads, Optimal Capital Structure, And Implied Volatility With Endogenous Default And Jump Risk," Mathematical Finance, Wiley Blackwell, vol. 19(3), pages 343-378, July.
    20. White, Alan, 2018. "Pricing Credit Default Swap Subject to Counterparty Risk and Collateralization," MPRA Paper 85331, University Library of Munich, Germany.

    More about this item

    Keywords

    Credit risk; Recovery risk; Contagion; Bond portfolio; Value-at-Risk;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G01 - Financial Economics - - General - - - Financial Crises
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:11:y:2014:i:2:p:131-139. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/frl .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.