Taken to the Limit: Simple and Not-so-Simple Loan Loss Distributions
23 Pages Posted: 3 Apr 2003
Date Written: August 2002
Abstract
Formulae for the distribution of the losses of a loan portfolio that are both realistic and simple enough to be implemented in a spreadsheet are hard to come by. The most prominent example is the Vasicek (1987) formula which is based upon a simplified version of the multivariate Merton (1974) model (the CreditMetrics model). Using an algorithm from the theory of Archimedean Copula functions, this paper gives some more limiting loss distributions which are driven by random variables with different dependency structures. This allows us to study the effects of different specifications of the dependency structure on the overall portfolio default risk and in particular on the tail risk of the credit portfolio.
Keywords: credit risk, default correlation, CreditMetrics, copula functions
JEL Classification: G13, G33
Suggested Citation: Suggested Citation
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