On The Effectiveness of The Credit Portfolio Model by Liao and Chen (2006)
Date Issued
2008
Date
2008
Author(s)
Lin, Shu-Yu
Abstract
We employ CDX market data to empirically examine the effectiveness of the credit portfolio model developed by Liao and Chen (2006), which combines a cash flow based model with a conditional independent default approach. Our empirical results show the credit portfolio model underestimate 5 year credit spread of a Dow Jones CDX credit portfolio. There are several ways to modify the model, including alternative default threshold settings, employing market implied cash flow volatility, or superimposing jumps on the cash flow processes. Moreover, incorporating forward looking macroeconomic factors enables the model to catch rare events induced jumps in the credit spread.
Subjects
Multi-Period Credit Model
Cash flow
Factor copula
Portfolio Loss
Risk dynamics
CDX
Type
thesis
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