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

Abstract

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

Tente, Natalia, A Hierarchical Archimedean Copula for Portfolio Credit Risk Modelling (September 28, 2011). Natalia Puzanova. A hierarchical Archimedean copula for portfolio credit risk modelling. Deutsche Bundesbank Discussion Paper, Series 2: Banking and Financial Studies, No 14/2011.. Available at SSRN: https://ssrn.com/abstract=1934747 or http://dx.doi.org/10.2139/ssrn.1934747

Natalia Tente (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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