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Dependent Defaults and Losses with Factor Copula Models

Damien Ackerer and Thibault Vatter

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Abstract: We present a class of flexible and tractable static factor models for the term structure of joint default probabilities, the factor copula models. These high-dimensional models remain parsimonious with pair-copula constructions, and nest many standard models as special cases. The loss distribution of a portfolio of contingent claims can be exactly and efficiently computed when individual losses are discretely supported on a finite grid. Numerical examples study the key features affecting the loss distribution and multi-name credit derivatives prices. An empirical exercise illustrates the flexibility of our approach by fitting credit index tranche prices.

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Date: 2016-10, Revised 2018-01
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Published in Dependence Modeling, Volume 5, Issue 1, Pages 375-399, 2017

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