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Copula-Based Default Dependence Modelling: Where Do We Stand?

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  • Elisa Luciano

    ()

Abstract

Copula functions have proven to be extremely useful in describing joint default and survival probabilities in credit risk applications. We overview the state of the art and point out some open modelling issues. We discuss first joint default modelling in diffusion based structural models, then in intensity based ones, focusing on the possibility - and the dynamic inconsistency - of re-mapping a model of the second type into one of the first. For both types of models, we discuss calibration issues under the risk neutral measure, using the factor copula device. The survey leads us to focus on a non-diffusive structural model, which can be re-mapped in a dynamic consistent intensity-based one, and which can be calibrated under a risk neutral measure without assuming equicorrelation.

Suggested Citation

  • 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.
  • Handle: RePEc:icr:wpmath:21-2007
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    File URL: http://www.biblioecon.unito.it/biblioservizi/RePEc/icr/wp2007/ICERwp21-07.pdf
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    References listed on IDEAS

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    1. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
    2. Elisa Luciano & Wim Schoutens, 2006. "A multivariate jump-driven financial asset model," Quantitative Finance, Taylor & Francis Journals, vol. 6(5), pages 385-402.
    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, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
    5. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    6. Filippo Fiorani & Elisa Luciano, 2006. "Credit risk in pure jump structural models," ICER Working Papers - Applied Mathematics Series 6-2006, ICER - International Centre for Economic Research.
    7. Joshua V. Rosenberg, 2003. "Nonparametric pricing of multivariate contingent claims," Staff Reports 162, Federal Reserve Bank of New York.
    8. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    9. Filippo Fiorani & Elisa Luciano & Patrizia Semeraro, 2007. "Single and joint default in a structural model with purely discontinuous assets," Carlo Alberto Notebooks 41, Collegio Carlo Alberto.
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    Cited by:

    1. 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.

    More about this item

    Keywords

    default dependence; copula functions; risk neutral versus historical dependence;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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