A Bottom-Up Dynamic Model of Portfolio Credit Risk. Part I: Markov Copula Perspective

Tomasz R. Bielecki, Areski Cousin, Stéphane Crépey and Alexander Herbertsson

Chapter 2 in Recent Advances in Financial Engineering 2012:Proceedings of the International Workshop on Finance 2012, 2014, pp 25-49 from World Scientific Publishing Co. Pte. Ltd.

Abstract: We consider a bottom-up Markovian copula model of portfolio credit risk where instantaneous contagion is possible in the form of simultaneous defaults. Due to the Markovian copula nature of the model, calibration of marginals and dependence parameters can be performed separately using a two-steps procedure, much like in a standard static copula set-up. In this sense this model solves the bottom-up top-down puzzle which the CDO industry had been trying to do for a long time. It can be applied to any dynamic credit issue like consistent valuation and hedging of CDSs, CDOs and counterparty risk on credit portfolios.

Keywords: Financial Engineering; Mathematical Finance; Money & Banking; Risk Management; Real Option; Corporate Finance; Computational Finance (search for similar items in EconPapers)
Date: 2014
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