Consistent Assumptions for Modeling Credit Loss Correlations

Dhaene, Jan; Goovaerts, M. J.; Olieslagers, Ruben; Koch, Robert; Romijn, Olivier; Vanduffel, Steven

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Consistent Assumptions for Modeling Credit Loss Correlations

Journal of Actuarial Practice, Vol. 13, pp. 173-182, 2006

10 Pages Posted: 19 May 2009

See all articles by Jan Dhaene

Steven Vanduffel

Vrije Universiteit Brussel (VUB)

Abstract

We consider a single period portfolio of n dependent credit risks that are subject to default during the period.

We show that using stochastic loss given default random variables in conjunction with default correlations can give rise to an inconsistent set of assumptions for estimating the variance of the portfolio loss.

Two sets of consistent assumptions are provided, which it turns out, also provide bounds on the variance of the portfolio’s loss. An example of an inconsistent set of assumptions is given.

Keywords: default correlation, loss correlation, comonotonicity, credit risk, LGD, Solvency II, Basel II

Suggested Citation: Suggested Citation

Dhaene, Jan and Goovaerts, M.J. and Olieslagers, Ruben and Koch, Robert and Romijn, Olivier and Vanduffel, Steven, Consistent Assumptions for Modeling Credit Loss Correlations. Journal of Actuarial Practice, Vol. 13, pp. 173-182, 2006 , Available at SSRN: https://ssrn.com/abstract=1406866