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Invite colleaguesModelling correlations in credit portfolio risk
Abstract
A credit portfolio's risk level depends on correlations between latent covariates, such as the probability of default in different economic sectors. Correlations often have to be estimated from relatively short time series, and the resulting estimation error hinders the detection of a signal. This paper suggests a general method of parameter estimation which avoids, in a controlled way, the underestimation of correlation risk. The paper presents empirical evidence to show how, in the framework of the CreditRisk+ model with integrated correlations, this method leads to an increased economic capital estimate. In this way, the limits of detecting the portfolio's diversification potential are adequately reflected.
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Citation
Rosenow, Bernd and Weissbach, Rafael (2010, January 1). Modelling correlations in credit portfolio risk. In the Journal of Risk Management in Financial Institutions, Volume 3, Issue 1.Publications LLP