IDEAS home Printed from https://ideas.repec.org/p/fip/fedgfe/1997-27.html

Default correlation: an analytical result

Author

Listed:
  • Chunsheng Zhou

Abstract

Evaluating default correlations and the probabilities of multiple defaults is an important task in credit analysis and risk management, but it has never been an easy one because default correlations cannot be measured directly. This paper provides, for the first time, an analytical formula for calculating default correlations based on a first-passage-time model that can be easily implemented and conveniently used in a variety of financial applications. This paper also provides a theoretical justification for many empirical results found in the literature and increases our understanding of the important features of default correlations.

Suggested Citation

  • Chunsheng Zhou, 1997. "Default correlation: an analytical result," Finance and Economics Discussion Series 1997-27, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:1997-27
    as

    Download full text from publisher

    File URL: http://www.federalreserve.gov/pubs/feds/1997/199727/199727abs.html
    Download Restriction: no
    File URL: http://www.federalreserve.gov/pubs/feds/1997/199727/199727pap.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Chunsheng Zhou, 1997. "A jump-diffusion approach to modeling credit risk and valuing defaultable securities," Finance and Economics Discussion Series 1997-15, Board of Governors of the Federal Reserve System (U.S.).
    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. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
    2. Dermine, Jean & Lajeri, Fatma, 2001. "Credit risk and the deposit insurance premium: a note," Journal of Economics and Business, Elsevier, vol. 53(5), pages 497-508.
    3. Mark Carey, 2001. "Dimensions of Credit Risk and Their Relationship to Economic Capital Requirements," NBER Chapters, in: Prudential Supervision: What Works and What Doesn't, pages 197-232, National Bureau of Economic Research, Inc.
    4. Bandyopadhyay, Arindam, 2010. "Understanding the Effect of Concentration Risk in the Banks’ Credit Portfolio: Indian Cases," MPRA Paper 24822, University Library of Munich, Germany.
    5. Battiston, Stefano & Delli Gatti, Domenico & Gallegati, Mauro & Greenwald, Bruce & Stiglitz, Joseph E., 2012. "Liaisons dangereuses: Increasing connectivity, risk sharing, and systemic risk," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1121-1141.
    6. Xin Gao & Binlin Wu & Tobias Schäfer, 2017. "Introducing an analytical solution and an improved one-factor gaussian copula model for the pricing of heterogeneous CDOs," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(02n03), pages 1-17, June.
    7. Carey, Mark, 2002. "A guide to choosing absolute bank capital requirements," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 929-951, May.
    8. Jones, David & Mingo, John, 1999. "Credit risk modeling and internal capital allocation processes: implications for a models-based regulatory bank capital standard," Journal of Economics and Business, Elsevier, vol. 51(2), pages 79-108, March.
    9. Palombini, Edgardo, 2009. "Factor models and the credit risk of a loan portfolio," MPRA Paper 20107, University Library of Munich, Germany.
    10. Cowan, Adrian M. & Cowan, Charles D., 2004. "Default correlation: An empirical investigation of a subprime lender," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 753-771, April.
    11. Lucas, Andre & Klaassens, Pieter & Spreij, Peter & Straetmans, Stefan, 2002. "Erratum to "An analytic approach to credit risk of large corporate bond and loan portfolios" [Journal of Banking and Finance 25, no. 9, pp. 1635-1664]," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 201-202, January.
    12. Dariusz Gatarek & Juliusz Jabłecki, 2013. "A model for dependent defaults and pricing contingent claims with counterparty risk," NBP Working Papers 150, Narodowy Bank Polski.
    13. Richa Verma Bajaj, 2018. "Credit Risk Capital Estimation Under IRB Approach for Banks in India," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 16(2), pages 475-500, June.
    14. Qian, Qian & Yang, Yang & Gu, Jing & Feng, Hairong, 2019. "Information authenticity, spreading willingness and credit risk contagion – A dual-layer network perspective," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 536(C).

    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. Trueck, Stefan & Rachev, Svetlozar T., 2008. "Rating Based Modeling of Credit Risk," Elsevier Monographs, Elsevier, edition 1, number 9780123736833.
    2. Viviana Fanelli & Silvana Musti, 2007. "Modelling Credit Spreads evolution using the Cox Process within the HJM framework," Quaderni DSEMS 27-2007, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia.
    3. Kyriakos Georgiou & Athanasios N. Yannacopoulos, 2023. "Probability of Default modelling with L\'evy-driven Ornstein-Uhlenbeck processes and applications in credit risk under the IFRS 9," Papers 2309.12384, arXiv.org.
    4. Jumbe, George, 2023. "Credit Risk Assessment Using Default Models: A Review," OSF Preprints ksb8n, Center for Open Science.
    5. Somnath Chatterjee & Andreas Jobst, 2019. "Market-implied systemic risk and shadow capital adequacy," Bank of England working papers 823, Bank of England.
    6. Chiarella, Carl & Fanelli, Viviana & Musti, Silvana, 2011. "Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model," European Journal of Operational Research, Elsevier, vol. 208(2), pages 95-108, January.
    7. 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, January-A.
    8. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.
    9. Mercadier, Mathieu & Lardy, Jean-Pierre, 2019. "Credit spread approximation and improvement using random forest regression," European Journal of Operational Research, Elsevier, vol. 277(1), pages 351-365.
    10. Bauerle, Nicole, 2002. "Risk management in credit risk portfolios with correlated assets," Insurance: Mathematics and Economics, Elsevier, vol. 30(2), pages 187-198, April.
    11. Becchetti, Leonardo & Carpentieri, Andrea & Hasan, Iftekhar, 2009. "The determinants of option-adjusted delta credit spreads : a comparative analysis of the United States, the United Kingdom and the euro area," Research Discussion Papers 34/2009, Bank of Finland.
    12. Luis H. R. Alvarez & Jani Sainio, 2010. "A Loan Portfolio Model Subject to Random Liabilities and Systemic Jump Risk," Papers 1006.0863, arXiv.org.
    13. Daniel Law & Mr. Shaun K. Roache, 2015. "Assessing Default Risks for Chinese Firms: A Lost Cause?," IMF Working Papers 2015/140, International Monetary Fund.
    14. Alexander David, 1998. "Pricing the strategic value of poison put bonds," Finance and Economics Discussion Series 1998-06, Board of Governors of the Federal Reserve System (U.S.).
    15. Campi, Luciano & Polbennikov, Simon & Sbuelz, Alessandro, 2009. "Systematic equity-based credit risk: A CEV model with jump to default," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 93-108, January.
    16. Xin Guo & Robert A. Jarrow & Yan Zeng, 2009. "Credit Risk Models with Incomplete Information," Mathematics of Operations Research, INFORMS, vol. 34(2), pages 320-332, May.
    17. Stuart Turnbull & Jun Yang, 2004. "Modelling the Evolution of Credit Spreads in the United States," Staff Working Papers 04-45, Bank of Canada.
    18. Campi, L. & Polbennikov, S.Y. & Sbuelz, A., 2005. "Assessing Credit with Equity : A CEV Model with Jump to Default," Discussion Paper 2005-27, Tilburg University, Center for Economic Research.
    19. Campi, L. & Sbuelz, A., 2005. "Close-Form Pricing of Benchmark Equity Default Swaps Under the CEV Assumption," Discussion Paper 2005-28, Tilburg University, Center for Economic Research.
    20. repec:wyi:journl:002109 is not listed on IDEAS
    21. J.W. Nieuwenhuis & M.H. Vellekoop, 2004. "Weak convergence of tree methods, to price options on defaultable assets," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 27(2), pages 87-107, December.

    More about this item

    Keywords

    ;
    ;
    ;

    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:fip:fedgfe:1997-27. 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: Ryan Wolfslayer ; Keisha Fournillier (email available below). General contact details of provider: https://edirc.repec.org/data/frbgvus.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.