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Interaction of market and credit risk: an analysis of inter-risk correlation and risk aggregation

Martin Hillebrand and Klaus Böcker

No 2008,11, Discussion Paper Series 2: Banking and Financial Studies from Deutsche Bundesbank

Abstract: In this paper we investigate the interaction between a credit portfolio and another risk type, which can be thought of as market risk. Combining Merton-like factor models for credit risk with linear factor models for market risk, we analytically calculate their interrisk correlation and show how inter-risk correlation bounds can be derived. Moreover, we elaborate how our model naturally leads to a Gaussian copula approach for describing dependence between both risk types. In particular, we suggest estimators for the correlation parameter of the Gaussian copula that can be used for general credit portfolios. Finally, we use our findings to calculate aggregated risk capital of a sample portfolio both by numerical and analytical techniques.

Keywords: Risk aggregation; Inter-risk correlation; economic capital; ICAAP; diversification (search for similar items in EconPapers)
JEL-codes: C13 G21 G28 G31 (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-fmk and nep-rmg
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Citations: View citations in EconPapers (4) Track citations by RSS feed

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