Results 1  10
of
28
A JumpDiffusion Approach to Modeling Credit Risk and Valuing Defaultable Securities
, 1997
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The intersection of market and credit risk
, 2000
"... Economic theory tells us that market and credit risks are intrinsically related to each other and not separable. We describe the two main approaches to pricing credit risky instruments: the structural approach and the reduced form approach. It is argued that the standard approaches to credit risk ma ..."
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Cited by 33 (2 self)
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Economic theory tells us that market and credit risks are intrinsically related to each other and not separable. We describe the two main approaches to pricing credit risky instruments: the structural approach and the reduced form approach. It is argued that the standard approaches to credit risk management  CreditMetrics, CreditRisk+ and KMV  are of limited value when applied to portfolios of interest rate sensitive instruments and in measuring market and credit risk. Empirically returns on high yield bonds have a higher correlation with equity index returns and a lower correlation with Treasury bond index returns than do low yield bonds. Also, macro economic variables appear to influence the aggregate rate of business failures. The CreditMetrics, CreditRisk+ and KMV methodologies cannot reproduce these empirical observations given their constant interest rate assumption. However, we can incorporate these empirical observations into the reduced form of Jarrow and Turnbull (1995b). Drawing the analogy. Risk 5, 6370 model. Here default probabilities are correlated due to their dependence on common economic factors.
Correlations and Business Cycles of Credit Risk: Evidence from Bankruptcies
 in Germany, Financial Markets and Portfolio Management
, 2003
"... A major topic in empirical finance is correlation of default risk. Correlations are the main drivers for credit risk on a portfolio basis and for banks ’ capital requirements under the New Basel Accord. However, empirical evidence on the magnitude of correlations is rather scarce, mainly due to dat ..."
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Cited by 8 (2 self)
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A major topic in empirical finance is correlation of default risk. Correlations are the main drivers for credit risk on a portfolio basis and for banks ’ capital requirements under the New Basel Accord. However, empirical evidence on the magnitude of correlations is rather scarce, mainly due to data limitations. Using a large database of bankruptcies in Germany we estimate correlations using a simple version of the Basel II factor model. Then we extend the model to an approach with observable risk factors and suggest that this model with default probabilities depending on the state of the economy may be more adequate. Empirical evidence on proxies for the credit cycles is presented for German industry sectors. We find that much of the comovements can be explained by our variables. Finally, we discuss some implications for forecasts of distributions of potential future defaults of a bank’s portfolio. 1
Valuing Foreign Exchange Rate Derivatives with a Bounded Exchange Process †
, 1995
"... Abstract. Foreign exchange rates have been subjected to periods of tighter or looser controls as various political and economic forces have waxed and waned. When currencies were backed by gold there were fixed exchange rates. In 1973 floating exchange rates were adopted though many countries did try ..."
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Cited by 4 (0 self)
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Abstract. Foreign exchange rates have been subjected to periods of tighter or looser controls as various political and economic forces have waxed and waned. When currencies were backed by gold there were fixed exchange rates. In 1973 floating exchange rates were adopted though many countries did try to keep their currency values within certain ranges. More recently the European Economic Community formalized this practice. Freefloating exchange rates might be well characterized by the lognormal distribution which is standard in option pricing. However, this is probably a poor approximation for exchange rates which are kept within some range by the actions of one or both governments or central banks. This paper develops a model which can be used to value options and other derivative contracts when the underlying exchange rate is bounded in a fixed range (a, b). Methods for pricing both European and American style options are developed.
MultiPeriod Defaults and Maturity Effects on Economic Capital in a RatingsBased DefaultMode Model
"... In the last decade, portfolio credit risk measurement has improved significantly. The current stateoftheart models analyze the value of the portfolio at a certain risk horizon, e.g. one year. Most popular has become the Mertontype onefactor model of Vasicek, that builds the fundament of the new ..."
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Cited by 1 (0 self)
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In the last decade, portfolio credit risk measurement has improved significantly. The current stateoftheart models analyze the value of the portfolio at a certain risk horizon, e.g. one year. Most popular has become the Mertontype onefactor model of Vasicek, that builds the fundament of the new capital adequacy framework (Basel II) finally adopted by the Basel Committee On Banking Supervision in June 2004. Due to this approach credit risk only arises from defaults, and the model provides an analytical solution for the risk measures Value at Risk and Expected Loss. One of the less examined questions in this field of research is, how the time to maturity of loans affects the portfolio credit risk. In practice there is common agreement that credit risk rises with the maturity of a loan, but only few solutions considering different maturities are discussed. We present two new approaches, how to cope with the problem of the maturity in the Vasicekmodel. We focus on the influence of the maturity in the theoretical framework of Merton and show solutions from empirical data of four rating agencies. Our results are close to the parameters, that are used in the maturity adjustment of Basel II and may help to get a better understanding on economic capital allocation of longterm loans.
A New Structural Approach to the Default Risk of Companies
, 2007
"... The Merton model, which is used for modeling default probabilities, is based on the assumption that the equity value is an option on the asset of a company with the strike price equal to the company debts. In the Merton model, it is implicitly assumed that debts last for a fixed period of time, and ..."
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The Merton model, which is used for modeling default probabilities, is based on the assumption that the equity value is an option on the asset of a company with the strike price equal to the company debts. In the Merton model, it is implicitly assumed that debts last for a fixed period of time, and determining the default point that is the strike price of the option has been controversial in the literature. In this paper, a new model is proposed that borrows the equity price determinant from the asset pricing literature where equity price is equal to present value of the expected dividends. The dividends should be paid from the asset surplus, which is the asset value minus the debts. Ultimately, the model will be proposed in which the parameters of asset surplus can be estimated from the equity prices without using the default point information. The empirical results show that the new model proposed in this paper has more information relative to the Merton model in explaining the default probabilities when the leverage of the company is fed to the model. 2
Discussion Paper Series 2: Banking and Financial Supervision No 01/2004
"... Discussion Papers represent the authors ’ personal opinions and do not necessarily reflect the views of the ..."
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Discussion Papers represent the authors ’ personal opinions and do not necessarily reflect the views of the
The Importance of Simultaneous Jumps in Default Correlation
, 2007
"... Correlated defaults have been an important area of research in credit risk analysis with the advent of a basket of credit derivatives. Even the simple credit derivatives should be considered a basket of two default risks since the bankruptcy risk of the derivative issuer is also a factor. Considerin ..."
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Correlated defaults have been an important area of research in credit risk analysis with the advent of a basket of credit derivatives. Even the simple credit derivatives should be considered a basket of two default risks since the bankruptcy risk of the derivative issuer is also a factor. Considering jumps in the asset value helps to model the surprise risk of default in a group of firms. Simultaneous jumps in the asset values of companies can explain the default correlation. The multivariate jump diffusion model is used for modeling the asset value in the structural approach to credit risk modeling. GMM implemented on the moments generated by empirical characteristic function is the method used for estimation of the parameters. The principal component method is used for reducing the hassle of moment conditions in the characteristic function estimation of the model. At the end, the empirical result of joint default credit risk of a basket of two firms, Ford and General Motors, are shown using two models: one without jump and the other one with the simultaneous jump. Model selection criterion proves that the model with jump is a better model. The model without simultaneous jump underestimates the joint default probability of two firms. 2
Correlated Random Walks and the Joint Survival Probability
"... First passage models, where corporate assets undergo correlated random walks and a company defaults if its assets fall below a threshold provide an attractive framework for modeling the default process. Typical one year default correlations are small, i.e., of order a few percent, but nonetheless in ..."
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First passage models, where corporate assets undergo correlated random walks and a company defaults if its assets fall below a threshold provide an attractive framework for modeling the default process. Typical one year default correlations are small, i.e., of order a few percent, but nonetheless including correlations is very important, for managing portfolio credit risk and pricing some credit derivatives (e.g. first to default baskets). In first passage models the exact dependence of the joint survival probability of more than two firms on their asset correlations is not known. We derive an expression for the dependence of the joint survival probability of n firms on their asset correlations using first order perturbation theory in the correlations. It includes all terms that are linear in the correlations but neglects effects of quadratic and higher order. For constant time independent correlations we compare the first passage model expression for the joint survival probability with what a multivariate normal Copula function gives. As a practical application of our results we calculate the dependence of the five year joint survival probability for five basic industrials on their asset correlations. 1
VOLATILITY OF GDP, MACRO APPLICATIONS AND POLICY IMPLICATIONS OF REAL OPTIONS
"... The traditional marshallian rule of investing (abandoning) when the value of an underlying asset is above (below) the cost of an alternative investment is modified in the presence of uncertainty and irreversibility giving rise to an option component into decisions. This component is affected by the ..."
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The traditional marshallian rule of investing (abandoning) when the value of an underlying asset is above (below) the cost of an alternative investment is modified in the presence of uncertainty and irreversibility giving rise to an option component into decisions. This component is affected by the degree of volatility of underlying assets, which in turn can derive their volatility from the economy as a whole, affecting the investment process and therefore the accumulation of capital and future growth. In the same tense, the evidence of volatility in the returns of the underlying assets of the economy affects the market value of debt contracts, conveying recommendations regarding the financial architecture of the economy and the type of financial instruments better suited. The paper explores the application of contingent claims analysis both to the potential effect of macro volatility on aggregate investment, and to the effect on the presence of high levels of indebtedness of the economy, with a special application to the Argentinean economy where we obtain that economies with high level of volatility would require a significant level of internal saving and capital markets driven mainly by equity instruments of financing, which helps to better accommodate uncertainty by means of the price of assets.