Modeling joint defaults in correlation-sensitive instruments

Juliusz Jabłecki and Dariusz Gątarek

Journal of Credit Risk

Abstract: ABSTRACT This paper presents a simple model for joint defaults and shows how it can be applied;to pricing and risk-managing instruments that are sensitive to credit correlation, from;simple repos to collateralized debt obligations. The model relies on a conservative and intuitive representation of a systematic factor as a chain of dependencies running;through the whole economy. This allows capturing the concentration of defaults in;time and endogenously produces dynamics of default correlation as the model output;rather than its input.

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