A Bottom-Up Dynamic Model of Portfolio Credit Risk; Part I: Markov Copula Perspective

22 Pages Posted: 18 May 2011 Last revised: 7 Apr 2013

See all articles by Tomasz R. Bielecki

Tomasz R. Bielecki

Illinois Institute of Technology

Areski Cousin

Université Lyon 1 - ISFA

Stéphane Crépey

Université d'Évry - Equipe d'Analyse et Probabilites

Alexander Herbertsson

University of Gothenburg - Department of Economics/Centre for Finance

Date Written: March 8, 2013

Abstract

We consider a bottom-up Markovian copula model of {portfolio} credit risk where instantaneous contagion is possible in the form of simultaneous defaults. Due to the Markovian copula nature of the model, calibration of marginals and dependence parameters can be performed separately using a two-steps procedure, much like in a standard static copula set-up. In this sense this model solves the bottom-up top-down puzzle which the CDO industry had been trying to do for a long time. It can be applied to any dynamic credit issue like consistent valuation and hedging of CDSs, CDOs and counterparty risk on credit portfolios.

Keywords: Portfolio Credit Risk, Credit Derivatives, Markov Copula Model, Common Shocks, Dynamic Hedging

Suggested Citation

Bielecki, Tomasz R. and Cousin, Areski and Crépey, Stéphane and Herbertsson, Alexander, A Bottom-Up Dynamic Model of Portfolio Credit Risk; Part I: Markov Copula Perspective (March 8, 2013). Available at SSRN: https://ssrn.com/abstract=1844574 or http://dx.doi.org/10.2139/ssrn.1844574

Tomasz R. Bielecki

Illinois Institute of Technology ( email )

Department of Applied Mathematics
10 W. 32nd Street
Chicago, IL 60616
United States
312 567 3185 (Phone)
312 567 3135 (Fax)

Areski Cousin

Université Lyon 1 - ISFA ( email )

50 avenue Tony Garnier
69007, Lyon
France

Stéphane Crépey

Université d'Évry - Equipe d'Analyse et Probabilites ( email )

Boulevard des Coquibus
F-91025 Evry Cedex
France

Alexander Herbertsson (Contact Author)

University of Gothenburg - Department of Economics/Centre for Finance ( email )

Box 640
Vasagatan 1, E-building, floor 5 & 6
Göteborg, 40530
Sweden

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