On Correlation and Default Clustering in Credit Markets

52 Pages Posted: 17 Mar 2009 Last revised: 27 Oct 2009

See all articles by Antje Berndt

Antje Berndt

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Applied Statistics

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance

Zhiqiang Sun

National City Bank

Date Written: October 25, 2009

Abstract

We establish Markovian models in the Heath, Jarrow and Morton paradigm that permit an exponential affine representation of riskless and risky bond prices while offering significant flexibility in the choice of volatility structures. Estimating models in our family is typically no more difficult than estimating term structure models in the workhorse affine family. In addition to diffusive and jump-induced default correlations, default events can impact credit spreads of surviving firms. This feature allows a greater clustering of defaults. Numerical implementations highlight the importance of taking interest rate-credit spread correlations, credit spread impact factors and the full credit spread curve information into account when building a unified model framework that prices any credit derivative.

Keywords: Markovian HJM Models, Credit Derivatives, Default Clustering, Counterparty Credit Risk

JEL Classification: C32, C51, G12

Suggested Citation

Berndt, Antje and Ritchken, Peter H. and Sun, Zhiqiang, On Correlation and Default Clustering in Credit Markets (October 25, 2009). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1361328 or http://dx.doi.org/10.2139/ssrn.1361328

Antje Berndt

Australian National University (ANU) - Research School of Finance, Actuarial Studies and Applied Statistics ( email )

Canberra, ACT 0200
Australia

HOME PAGE: http://www.cbe.anu.edu.au/about/staff-directory/?profile=Antje-Berndt

Peter H. Ritchken (Contact Author)

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3849 (Phone)
216-368-4776 (Fax)

Zhiqiang Sun

National City Bank ( email )

National City Center
1900 East Ninth Street
Cleveland, OH 44114-3484
United States

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