A Hierarchical Archimedean Copula for Portfolio Credit Risk Modelling
Natalia Puzanova. A hierarchical Archimedean copula for portfolio credit risk modelling. Deutsche Bundesbank Discussion Paper, Series 2: Banking and Financial Studies, No 14/2011.
22 Pages Posted: 28 Sep 2011 Last revised: 5 Sep 2012
Date Written: September 28, 2011
I introduce a novel, hierarchical model of tail dependent asset returns which can be particularly useful for measuring portfolio credit risk within the structural framework. To allow for a stronger dependence within sub-portfolios than between them, I utilise the concept of nested Archimedean copulas, but modify the nesting procedure to ensure the compatibility of copula generators by construction. This makes sampling straightforward. Moreover, I provide details on a particular specification based on a gamma mixture of powers. This model allows for lower tail dependence, resulting in a more conservative credit risk assessment than a comparable Gaussian model. I illustrate the extent of model risk when calculating VaR or Expected Shortfall for a credit portfolio.
Keywords: Portfolio Credit Risk, Nested Archimedean Copula, Tail Dependence, Hierarchical Dependence Structure
JEL Classification: C46, C63, G21
Suggested Citation: Suggested Citation