Managing Credit Risk with Credit and Macro Derivatives
University of Augsburg Economics Discussion Paper No. 252
21 Pages Posted: 16 Dec 2003
Date Written: November 2003
The industrial organization approach to the microeconomics of banking augmented by uncertainty and risk aversion is used to examine credit derivatives and macro derivatives as instruments to hedge credit risk for a large commercial bank. In a partial-analytic framework we distinguish between the probability of default and the loss given default, model different forms of derivatives, and derive hedge rules and strong and weak separation properties between deposit and loan decisions on the one hand and hedging decisions on the other. We also suggest how bank-specific macro derivatives could be designed from common macro indices which serve as underlyings of recently introduced financial products.
Keywords: banking, credit risk, systematic risk, credit derivative, macro derivative
JEL Classification: G21
Suggested Citation: Suggested Citation
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By James Huang