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The Empirical Relation between Credit Quality, Recovery, and Correlation

Daniel Rosch and Harald Scheule
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Daniel Rosch: Leibniz Universitat Hannover

No 222009, Working Papers from Hong Kong Institute for Monetary Research

Abstract: The majority of industry credit portfolio risk models, as well as recent scientific results, are based on isolated modules for default probabilities and recoveries in the event of default. This paper shows that these common methods lead to various econometric drawbacks when the parameters are interpreted and aggregated for risk capital allocation and pricing purposes. This paper provides a top down approach in which individual credit risk parameters are derived analytically from a single model. This model allows for a i) dynamic, ii) consistent, and iii) unbiased modeling of credit portfolio risks. An empirical analysis provides evidence for the inferred relationship between credit quality, recovery and correlation.

Keywords: Asset Value; Correlation; Credit Portfolio; Loss Given Default; Merton Model; Probability of Default; Recovery; Volatility (search for similar items in EconPapers)
JEL-codes: G20 G28 C51 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2009-07
New Economics Papers: this item is included in nep-ban, nep-ore and nep-rmg
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Working Paper: The Empirical Relation between Credit Quality, Recovery and Correlation (2009) Downloads
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