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Author
I. Anagnostou
S. Sourabh
D. Kandhai
Date
8-1-2018
Title
Incorporating Contagion in Portfolio Credit Risk Models Using Network Theory
Journal
Complexity
Volume
2018
Article number
6076173
Number of pages
15
Document type
Article
Faculty
Faculty of Science (FNWI)
Institute
Informatics Institute (IVI)
Abstract
Portfolio credit risk models estimate the range of potential losses due to defaults or deteriorations in credit quality. Most of these models perceive default correlation as fully captured by the dependence on a set of common underlying risk factors. In light of empirical evidence, the ability of such a conditional independence framework to accommodate for the occasional default clustering has been questioned repeatedly. Thus, financial institutions have relied on stressed correlations or alternative copulas with more extreme tail dependence. In this paper, we propose a different remedy—augmenting systematic risk factors with a contagious default mechanism which affects the entire universe of credits. We construct credit stress propagation networks and calibrate contagion parameters for infectious defaults. The resulting framework is implemented on synthetic test portfolios wherein the contagion effect is shown to have a significant impact on the tails of the loss distributions.
URL
go to publisher's site
Language
English
Permalink
http://hdl.handle.net/11245.1/cb9f1f4d-21f8-40a6-8090-b007b00dee9c
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  • Incorporating Contagion in Portfolio Credit Risk Models

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