Contagious Defaults in a Credit Portfolio: A Bayesian Network Approach

22 Pages Posted: 7 Sep 2019

See all articles by Ioannis Anagnostou

Ioannis Anagnostou

University of Amsterdam; ING Bank - Netherlands Office

Javier Sánchez Rivero

University of Amsterdam

Sumit Sourabh

University of Amsterdam

Drona Kandhai

University of Amsterdam; ING Bank - Netherlands Office

Date Written: August 5, 2019

Abstract

Robustness of credit portfolio models is of great interest for financial institutions and regulators, since misspecified models translate to insufficient capital buffers and a crisis-prone financial system. In this paper, we propose a method to enhance credit portfolio models based on the model of Merton by incorporating contagion effects. While in most models the risks related to financial interconnectedness are neglected, we use Bayesian network methods to uncover the direct and indirect relationships between credits, while maintaining the convenient representation of factor models. A range of techniques to learn the structure and parameters of financial networks from real Credit Default Swaps (CDS) data is studied and evaluated. Our approach is demonstrated in detail in a stylized portfolio and the impact on standard risk metrics is estimated.

Keywords: Portfolio Credit Risk, Bayesian Learning, Credit Default Swaps, Default Contagion, Probabilistic Graphical Models, Network Theory

JEL Classification: C11, C15, C53, C60, C63, G11, L14

Suggested Citation

Anagnostou, Ioannis and Sánchez Rivero, Javier and Sourabh, Sumit and Kandhai, Drona, Contagious Defaults in a Credit Portfolio: A Bayesian Network Approach (August 5, 2019). Available at SSRN: https://ssrn.com/abstract=3446615 or http://dx.doi.org/10.2139/ssrn.3446615

Ioannis Anagnostou (Contact Author)

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

ING Bank - Netherlands Office ( email )

1102 MG Amsterdam
P.O. Box 1800
1000 BV Amsterdam
Netherlands

Javier Sánchez Rivero

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

Sumit Sourabh

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

Drona Kandhai

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

ING Bank - Netherlands Office

1102 MG Amsterdam
P.O. Box 1800
1000 BV Amsterdam
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
38
Abstract Views
176
PlumX Metrics