Systematic Credit Risk: CDX Index Correlation and Extreme Dependence

23 Pages Posted: 18 Sep 2007

See all articles by Sofiane Aboura

Sofiane Aboura

Université Paris XIII Nord - Department of Economics and Management

Niklas Wagner

Passau University

Date Written: September 2007

Abstract

Dependence is an important issue in credit risk portfolio modeling and pricing. We discuss a straightforward common factor model of credit risk dependence, which is motivated by intensity models such as Duffie and Singleton (1998), among others. In the empirical analysis, we study dependence under the risk-neutral measure using credit default swap (CDS) spread data of liquid large-cap U.S. obligors. The proxy for the common factor is the DJ CDX.NA.IG index. We document that (i) the CDX factor is significant but has low explanatory power, (ii) factor sensitivities show distinct time-varying nature and that (iii) systematic credit risk shows asymmetric extreme factor dependence, where extreme dependence is present for upward CDX movements only. This finding from an EVT-copula approach is what is predicted by various intensity models of joint defaults.

Keywords: credit risk, factor model, time-varying risk, extreme dependence

JEL Classification: G12, G13

Suggested Citation

Aboura, Sofiane and Wagner, Niklas F., Systematic Credit Risk: CDX Index Correlation and Extreme Dependence (September 2007). Available at SSRN: https://ssrn.com/abstract=1012626 or http://dx.doi.org/10.2139/ssrn.1012626

Sofiane Aboura

Université Paris XIII Nord - Department of Economics and Management ( email )

99 avenue Jean-Baptiste
Clément, Villetaneuse 93430
France

Niklas F. Wagner (Contact Author)

Passau University ( email )

Innstrasse 27
Passau, 94030
Germany

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