Default probabilities and default correlations

Ulrich Erlenmaier and Hans Gersbach

No 01-5, Research Notes from Deutsche Bank Research

Abstract: Starting from the Merton framework for firm defaults, we provide the analytics and robustness of the relationship between default correlations. We show that loans with higher default probabilities will not only have higher variances but also higher correlations between loans. As a consequence, portfolio standard deviation can increase substantially when loan default probabilities rise. This result has two important implications. First, relative prices of loans with different default probabilities should reflect the differential impact on portfolio standard deviation. Second, the standard deviation of loan portfolios and of default rates, as well as the required economic capital will vary significantly over the business cycle.

Keywords: Credit portfolio management; Default correlations; Pricing of loans; Macroeconomic risk; Credit risk models (search for similar items in EconPapers)
JEL-codes: G11 G12 G21 G31 (search for similar items in EconPapers)
Date: 2001
References: Add references at CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
https://www.econstor.eu/bitstream/10419/40256/1/341385050.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:dbrrns:015

Access Statistics for this paper

More papers in Research Notes from Deutsche Bank Research Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics ().