The pricing of portfolio credit risk

Nikola Tarashev () and Zhu Haibin

No 214, BIS Working Papers from Bank for International Settlements

Abstract: Equity and credit-default-swap (CDS) markets are in disagreement as to the extent to which asset returns co-move across firms. This suggests market segmentation and casts ambiguity about the asset-return correlations underpinning observed prices of portfolio credit risk. The ambiguity could be eliminated by – currently unavailable – data that reveal the market valuation of low-probability/large-impact events. At present, judicious assumptions about this valuation can be used to reconcile observed prices with asset-return correlations implied by either equity or CDS markets. These conclusions are based on an analysis of tranche spreads of a popular CDS index, which incorporate a rather small premium for correlation risk.

Keywords: CDS index tranche; joint distribution of asset returns; correlation risk premium; copula (search for similar items in EconPapers)
JEL-codes: C15 G13 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2006-09
New Economics Papers: this item is included in nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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