Default Contagion in Large Homogeneous Portfolios

Alexander Herbertsson (alexander.herbertsson@economics.gu.se)
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Alexander Herbertsson: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: Box 640, SE 40530 GÖTEBORG

No 272, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: We study default contagion in large homogeneous credit portfolios. Using data from the iTraxx Europe series, two synthetic CDO portfolios are calibrated against their tranche spreads, index CDS spreads and average CDS spreads, all with five year maturity. After the calibrations, which render perfect fits, we investigate the implied expected ordered defaults times, implied default correlations, and implied multivariate default and survival distributions, both for ordered and unordered default times. Many of the numerical results differ substantially from the corresponding quantities in a smaller inhomogeneous CDS portfolio. Furthermore, the studies indicate that market CDO spreads imply extreme default clustering in upper tranches. The default contagion is introduced by letting individual intensities jump when other defaults occur, but be constant between defaults. The model is translated into a Markov jump process. Expressions for the investigated quantities are derived by using matrix-analytic methods.

Keywords: Credit risk; intensity-based models; dependence modelling; default contagion; Markov jump processes; Matrix-analytic methods; synthetic CDO-s; index CDS-s (search for similar items in EconPapers)
JEL-codes: C02 C63 G13 G32 G33 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2007-10-31
New Economics Papers: this item is included in nep-rmg
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Citations:

Forthcoming in The Credit Derivatives Handbook : Global Perspectives, Innovations and Market Drivers, Gregoriou, Greg N. , Ali, Paul (eds.), 2007, chapter xx, McGraw-Hill.

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