Portfolio credit risk of default and spread widening

Hongbiao Zhao

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper introduces a new model for portfolio credit risk incorporating default and spread widening in a simple and consistent framework. Credit spreads are modelled by geometric Brownian motions with a dependence structure powered by a t-copula. Their joint evolution drives the spreads widening and triggers defaults, and then the loss can be calculated accordingly. It is a heterogeneous model that takes account of different credit ratings and term structures for each underlying spread. This model is applicable to portfolio credit risk management, stress test, or to fit into regulatory capital requirements. The procedures of parameter calibration and scenario simulation are provided. A detailed example is also given to see how this proposed model can be implemented in practice.

Keywords: portfolio credit risk; stress test; economic capital; default risk; spread widening risk; Copula; Basel III (search for similar items in EconPapers)
JEL-codes: C30 C51 G18 G32 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2011-12-06
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