Integrating Market and Credit Risk Using a Simplified Frailty Default Correlation Structure
Resource
The Journal of Fixed Income,17(4),48-58.
Journal
The Journal of Fixed Income
Pages
48-58
Date Issued
2007-08
Date
2007-08
Author(s)
Kuo, C. K.
Lee, C. W
Abstract
This article adopts a simplified approach to assess the correlation structure of credit risk. The approach could significantly reduce the numbers of estimated parameters in credit risk measurement. Thus it provides a simple way to integrate market risk smoothly that leads to a unified framework for computing fixed-income portfolio Value at Risk (VaR). Furthermore, based on recent research findings that frailty factors could induce a large estimated increase in default clustering, we also consider frailty variables in our integrated model. Using a portfolio as illustration, it is shown that the traditional approach where the correlation of market and credit risk is not considered, or frailty is not accounted for, may under-estimate VaR. TOPICS:Fixed income and structured finance, VAR and use of alternative risk measures of trading risk, credit risk management
Type
journal article