Estimating Default and Recovery Rate Correlations

Jiří Witzany

No 2013/03, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: The paper analyzes a two-factor credit risk model allowing to capture default and recovery rate variation, their mutual correlation, and dependence on various explanatory variables. At the same time, it allows computing analytically the unexpected credit loss. We propose and empirically implement estimation of the model based on aggregate and exposure level Moody’s default and recovery data. The results confirm existence of significantly positive default and recovery rate correlation. We empirically compare the unexpected loss estimates based on the reduced two-factor model with Monte Carlo simulation results, and with the current regulatory formula outputs. The results show a very good performance of the proposed analytical formula which could feasibly replace the current regulatory formula.

Keywords: credit risk; Basel II regulation; default rates; recovery rates; correlation (search for similar items in EconPapers)
JEL-codes: C51 G20 G28 (search for similar items in EconPapers)
Pages: 28pages
Date: 2013-04, Revised 2013-04
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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