A NONPARAMETRIC URN-BASED APPROACH TO INTERACTING FAILING SYSTEMS WITH AN APPLICATION TO CREDIT RISK MODELING

Pasquale Cirillo (), Jürg Hüsler and Pietro Muliere
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Pasquale Cirillo: Institute of Mathematical Statistics and Actuarial Sciences, University of Bern, Sidlerstrasse 5, Bern, CH-3012, Switzerland
Jürg Hüsler: Institute of Mathematical Statistics and Actuarial Sciences, University of Bern, Sidlerstrasse 5, Bern, CH-3012, Switzerland
Pietro Muliere: Department of Decision Sciences, Bocconi University Via Röntgen 1, Milan, IT-20136, Italy

International Journal of Theoretical and Applied Finance (IJTAF), 2010, vol. 13, issue 08, 1223-1240

Abstract: In this paper we propose a new nonparametric approach to interacting failing systems (FS), that is systems whose probability of failure is not negligible in a fixed time horizon, a typical example being firms and financial bonds. The main purpose when studying a FS is to calculate the probability of default and the distribution of the number of failures that may occur during the observation period. A model used to study a failing system is defined default model. In particular, we present a general recursive model constructed by the means of interacting urns. After introducing the theoretical model and its properties we show a first application to credit risk modeling, showing how to assess the idiosyncratic probability of default of an obligor and the joint probability of failure of a set of obligors in a portfolio of risks, that are divided into reliability classes.

Keywords: Failing system; urn model; neutral to the right processes; credit risk; firms' defaults (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219024910006170

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