Portfolio Credit Risk of Default and Spread Widening

19 Pages Posted: 31 Aug 2011

See all articles by Hongbiao Zhao

Hongbiao Zhao

Shanghai University of Finance and Economics; London School of Economics & Political Science (LSE)

Date Written: August 3, 2011


This paper introduces a new model for portfolio credit risk incorporating default and spread widening in one consistent framework. Credit spreads are modelled by geometric Brownian motions with a dependence structure powered by a t-copula. Their joint evolution drives the spreads widening and triggers defaults, and then the loss can be calculated accordingly. It is a heterogeneous model that takes account of different credit rating and term structure for each underlying spread. This model is applicable to credit risk management, stress test, or to fit into regulatory capital requirements, particularly the Incremental Risk Charge. The procedures of parameter calibration and scenario simulation are provided, and a detailed example is also given to see how this proposed model can be implemented in practice.

Keywords: Portfolio Credit Risk, Stress Test, Economic Capital, Default Risk, Spread Widening Risk, Copula

JEL Classification: G32, G18, C30, C51 

Suggested Citation

Zhao, Hongbiao, Portfolio Credit Risk of Default and Spread Widening (August 3, 2011). 24th Australasian Finance and Banking Conference 2011 Paper. Available at SSRN: https://ssrn.com/abstract=1904635 or http://dx.doi.org/10.2139/ssrn.1904635

Hongbiao Zhao (Contact Author)

Shanghai University of Finance and Economics ( email )

No. 777 Guoding Road
Yangpu District
Shanghai, Shanghai 200433

HOME PAGE: http://hongbiaozhao.weebly.com/

London School of Economics & Political Science (LSE)

Houghton Street
London, WC2A 2AE
United Kingdom

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