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Tail behaviour of credit loss distributions for general latent factor models

Author

Listed:
  • Andre Lucas
  • Pieter Klaassen
  • Peter Spreij
  • Stefan Straetmans

Abstract

Using a limiting approach to portfolio credit risk, we obtain analytic expressions for the tail behavior of credit losses. To capture the co-movements in defaults over time, we assume that defaults are triggered by a general, possibly non-linear, factor model involving both systematic and idiosyncratic risk factors. The model encompasses default mechanisms in popular models of portfolio credit risk, such as CreditMetrics and CreditRisk+. We show how the tail characteristics of portfolio credit losses depend directly upon the factor model's functional form and the tail properties of the model's risk factors. In many cases the credit loss distribution has a polynomial (rather than exponential) tail. This feature is robust to changes in tail characteristics of the underlying risk factors. Finally, we show that the interaction between portfolio quality and credit loss tail behavior is strikingly different between the CreditMetrics and CreditRisk+ approach to modeling portfolio credit risk.

Suggested Citation

  • Andre Lucas & Pieter Klaassen & Peter Spreij & Stefan Straetmans, 2003. "Tail behaviour of credit loss distributions for general latent factor models," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(4), pages 337-357.
  • Handle: RePEc:taf:apmtfi:v:10:y:2003:i:4:p:337-357
    DOI: 10.1080/1350486032000160786
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    References listed on IDEAS

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    1. Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001. "An analytic approach to credit risk of large corporate bond and loan portfolios," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1635-1664, September.
    2. Bangia, Anil & Diebold, Francis X. & Kronimus, Andre & Schagen, Christian & Schuermann, Til, 2002. "Ratings migration and the business cycle, with application to credit portfolio stress testing," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 445-474, March.
    3. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January.
    4. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, August.
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    Citations

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    Cited by:

    1. Albrecht, Peter, 2005. "Kreditrisiken - Modellierung und Management: Ein Überblick," German Risk and Insurance Review (GRIR), University of Cologne, Department of Risk Management and Insurance, vol. 1(2), pages 22-152.
    2. André Lucas & Bernd Schwaab & Xin Zhang, 2017. "Modeling Financial Sector Joint Tail Risk in the Euro Area," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 32(1), pages 171-191, January.
    3. Hayette Gatfaoui, 2003. "How Does Systematic Risk Impact US Credit Spreads? A Copula Study," Risk and Insurance 0308002, EconWPA.
    4. Sak Halis, 2010. "Increasing the number of inner replications of multifactor portfolio credit risk simulation in the t-copula model," Monte Carlo Methods and Applications, De Gruyter, vol. 16(3-4), pages 361-377, January.
    5. Bologov , Yaroslav, 2013. "A copula-based approach to portfolio credit risk modeling," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 29(1), pages 45-66.
    6. Andre Lucas & Bernd Schwaab & Xin Zhang, 2013. "Measuring Credit Risk in a Large Banking System: Econometric Modeling and Empirics," Tinbergen Institute Discussion Papers 13-063/IV/DSF56, Tinbergen Institute, revised 13 Oct 2014.

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