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Default correlation: an analytical result

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  • 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
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    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. 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.
    3. Mark S. Carey, 2002. "A guide to choosing absolute bank capital requirements," International Finance Discussion Papers 726, Board of Governors of the Federal Reserve System (U.S.).
    4. 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.
    5. 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.
    6. 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.
    7. Bandyopadhyay, Arindam, 2010. "Understanding the Effect of Concentration Risk in the Banks’ Credit Portfolio: Indian Cases," MPRA Paper 24822, University Library of Munich, Germany.
    8. Mark Carey, 2000. "Dimensions of Credit Risk and Their Relationship to Economic Capital Requirements," NBER Working Papers 7629, National Bureau of Economic Research, Inc.
    9. Palombini, Edgardo, 2009. "Factor models and the credit risk of a loan portfolio," MPRA Paper 20107, University Library of Munich, Germany.
    10. Mark S. Carey, 2000. "Dimensions of credit risk and their relationship to economic capital requirements," Finance and Economics Discussion Series 2000-18, Board of Governors of the Federal Reserve System (U.S.).
    11. Carey, Mark, 2002. "A guide to choosing absolute bank capital requirements," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 929-951, May.
    12. 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.
    13. Mark S. Carey & Mark Hrycay, 2000. "Parameterizing credit risk models with rating data," Finance and Economics Discussion Series 2000-47, Board of Governors of the Federal Reserve System (U.S.).

    More about this item

    Keywords

    Credit ; Debt ; Risk;

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