IDEAS home Printed from https://ideas.repec.org/p/bdi/wptemi/td_892_12.html
   My bibliography  Save this paper

A dynamic default dependence model

Author

Listed:
  • Sara Cecchetti

    (Bank of Italy)

  • Giovanna Nappo

    (Sapienza, University of Rome)

Abstract

We develop a dynamic multivariate default model for a portfolio of credit-risky assets in which default times are modelled as random variables with possibly different marginal distributions, and L�vy subordinators are used to model the dependence among default times. In particular, we define a cumulative dynamic hazard process as a L�vy subordinator, which allows for jumps and induces positive probabilities of joint defaults. We allow the main asset classes in the portfolio to have different cumulative default probabilities and corresponding different cumulative hazard processes. Under this heterogeneous assumption we compute the portfolio loss distribution in closed form. Using an approximation of the loss distribution, we calibrate the model to the tranches of the iTraxx Europe. Once the multivariate default distribution has been estimated, we analyse the distress dependence in the portfolio by computing indicators of systemic risk, such as the Stability Index, the Distress Dependence Matrix and the Probability of Cascade Effects.

Suggested Citation

  • Sara Cecchetti & Giovanna Nappo, 2012. "A dynamic default dependence model," Temi di discussione (Economic working papers) 892, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_892_12
    as

    Download full text from publisher

    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2012/2012-0892/en_tema_892.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Barbara Choroś-Tomczyk & Wolfgang Karl H�rdle & Ludger Overbeck, 2014. "Copula dynamics in CDOs," Quantitative Finance, Taylor & Francis Journals, vol. 14(9), pages 1573-1585, September.
    2. Donnelly, Catherine & Embrechts, Paul, 2010. "The Devil is in the Tails: Actuarial Mathematics and the Subprime Mortgage Crisis," ASTIN Bulletin, Cambridge University Press, vol. 40(1), pages 1-33, May.
    3. Viktoriya Masol & Wim Schoutens, 2011. "Comparing alternative Levy base correlation models for pricing and hedging CDO tranches," Quantitative Finance, Taylor & Francis Journals, vol. 11(5), pages 763-773.
    4. Elisa Luciano, 2007. "Copula-Based Default Dependence Modelling: Where Do We Stand?," ICER Working Papers - Applied Mathematics Series 21-2007, ICER - International Centre for Economic Research.
    Full references (including those not matched with items on IDEAS)

    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. Gerardo Manzo & Antonio Picca, 2020. "The Impact of Sovereign Shocks," Management Science, INFORMS, vol. 66(7), pages 3113-3132, July.
    2. Meng-Jou Lu & Cathy Yi-Hsuan Chen & Wolfgang Karl Härdle, 2017. "Copula-based factor model for credit risk analysis," Review of Quantitative Finance and Accounting, Springer, vol. 49(4), pages 949-971, November.
    3. Gola, Carlo & Ilari, Antonio, 2015. "Financial innovation oversight: a policy framework," Journal of Financial Perspectives, EY Global FS Institute, vol. 3(1), pages 59-100.
    4. Liu, Jing, 2018. "LLN-type approximations for large portfolio losses," Insurance: Mathematics and Economics, Elsevier, vol. 81(C), pages 71-77.
    5. Payzan-LeNestour, Elise & Woodford, Michael, 2022. "Outlier blindness: A neurobiological foundation for neglect of financial risk," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1316-1343.
    6. Malekan, Sara & Dionne, Georges, 2014. "Securitization and optimal retention under moral hazard," Journal of Mathematical Economics, Elsevier, vol. 55(C), pages 74-85.
    7. Enrique Sentana, 2018. "Volatility, Diversification and Contagion," Working Papers wp2018_1803, CEMFI.
    8. Jaworski Piotr, 2023. "On copulas with a trapezoid support," Dependence Modeling, De Gruyter, vol. 11(1), pages 1-23, January.
    9. Cristiano Villa, 2017. "Bayesian estimation of the threshold of a generalised pareto distribution for heavy-tailed observations," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer;Sociedad de Estadística e Investigación Operativa, vol. 26(1), pages 95-118, March.
    10. Shogo Kato & Toshinao Yoshiba & Shinto Eguchi, 2022. "Copula-based measures of asymmetry between the lower and upper tail probabilities," Statistical Papers, Springer, vol. 63(6), pages 1907-1929, December.
    11. Choe, Geon Ho & Choi, So Eun & Jang, Hyun Jin, 2020. "Assessment of time-varying systemic risk in credit default swap indices: Simultaneity and contagiousness," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    12. Ascheberg, Marius & Bick, Björn & Kraft, Holger, 2013. "Hedging structured credit products during the credit crisis: A horse race of 10 models," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1687-1705.
    13. Ahmed, Hanan, 2022. "Extreme value statistics using related variables," Other publications TiSEM 246f0f13-701c-4c0d-8e09-e, Tilburg University, School of Economics and Management.
    14. Aleksy Leeuwenkamp & Wentao Hu, 2023. "New general dependence measures: construction, estimation and application to high-frequency stock returns," Papers 2309.00025, arXiv.org.
    15. Meng-Jou Lu & Cathy Yi-Hsuan Chen & Wolfgang Karl Hardle, 2020. "Copula-Based Factor Model for Credit Risk Analysis," Papers 2009.12092, arXiv.org, revised Oct 2020.
    16. Balkema, A.A. & Embrechts, P. & Nolde, N., 2010. "Meta densities and the shape of their sample clouds," Journal of Multivariate Analysis, Elsevier, vol. 101(7), pages 1738-1754, August.
    17. Shumin Ma & Zhiri Yuan & Qi Wu & Yiyan Huang & Xixu Hu & Cheuk Hang Leung & Dongdong Wang & Zhixiang Huang, 2023. "Deep into The Domain Shift: Transfer Learning through Dependence Regularization," Papers 2305.19499, arXiv.org.
    18. Christian Walter, 2020. "Sustainable Financial Risk Modelling Fitting the SDGs: Some Reflections," Sustainability, MDPI, vol. 12(18), pages 1-28, September.
    19. Hyun Jin Jang & Kiseop Lee & Kyungsub Lee, 2020. "Systemic risk in market microstructure of crude oil and gasoline futures prices: A Hawkes flocking model approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(2), pages 247-275, February.
    20. Sally G. Arcidiacono & Damiano Rossello, 2022. "A hybrid approach to the discrepancy in financial performance’s robustness," Operational Research, Springer, vol. 22(5), pages 5441-5476, November.

    More about this item

    Keywords

    L�vy subordinators; joint default probability; copula;
    All these keywords.

    JEL classification:

    • B26 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Financial Economics
    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:bdi:wptemi:td_892_12. 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: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/bdigvit.html .

    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.