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Copulas and Dependence models in Credit Risk: Diffusions versus Jumps

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  • Elisa Luciano

Abstract

The most common approach for default dependence modelling is at present copula functions. Within this framework, the paper examines factor copulas, which are the industry standard, together with their latest development, namely the incorporation of sudden jumps to default instead of a pure diffusive behavior. The impact of jumps on default dependence - through factor copulas - has not been fully explored yet. Our novel contribution consists in showing that modelling default arrival through a pure jump asset process does matter, even when the copula choice is thestandard, factor one, and the correlation is calibrated so as to match the diffusive and non diffusive case. An example from the credit derivative market is discussed.

Suggested Citation

  • Elisa Luciano, 2007. "Copulas and Dependence models in Credit Risk: Diffusions versus Jumps," ICER Working Papers - Applied Mathematics Series 31-2007, ICER - International Centre for Economic Research.
    • Handle: RePEc:icr:wpmath:31-2007
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    References listed on IDEAS

    as
    1. Dilip B. Madan & Peter P. Carr & Eric C. Chang, 1998. "The Variance Gamma Process and Option Pricing," Review of Finance, European Finance Association, vol. 2(1), pages 79-105.
    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. 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.
    4. Hélyette Geman & Dilip B. Madan & Marc Yor, 2001. "Time Changes for Lévy Processes," Mathematical Finance, Wiley Blackwell, vol. 11(1), pages 79-96, January.
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    More about this item

    Keywords

    credit risk; correlated defaults; structural models; Lévy processes; copula functions; factor copula;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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