Global Sensitivity Analysis for Latent Factor Credit Risk Models

29 Pages Posted: 3 Jan 2005

See all articles by Dirk G. Baur

Dirk G. Baur

University of Western Australia - Business School; Financial Research Network (FIRN)

Jessica Cariboni

Joint Research Center of the European Commission

Francesca Campolongo

Europoean Commission - Joint Reserach Centre; Joint Research Center of the European Commission

Date Written: November 2004

Abstract

This paper proposes the use of a global sensitivity analysis to evaluate the risk associated with a credit portfolio model. The main features of this approach are its ability to assess sensitivities in the presence of non-linearities and to rank the input factors with respect to their relevance for the output variable. The commonly used local sensitivity analysis which is nested in the global model cannot provide this information. We analyze the static and time-varying uncertainties of three key input factors in a latent factor credit risk model, i.e. the multivariate distribution (copula), the default correlation and the default probability. Results show that the importance of the factors strongly depends on the average default probability of the portfolio and the analyzed quantiles of the default distribution. The proposed technique also provides information about trade-offs between the factors, e.g. between the default correlation and the copula.

Keywords: Credit risk model, latent factor model, copula, global sensitivity analysis

JEL Classification: G31, C15, G11

Suggested Citation

Baur, Dirk G. and Cariboni, Jessica and Campolongo, Francesca, Global Sensitivity Analysis for Latent Factor Credit Risk Models (November 2004). Available at SSRN: https://ssrn.com/abstract=638563 or http://dx.doi.org/10.2139/ssrn.638563

Dirk G. Baur (Contact Author)

University of Western Australia - Business School ( email )

School of Business
35 Stirling Highway
Crawley, Western Australia 6009
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Jessica Cariboni

Joint Research Center of the European Commission ( email )

Via E. Fermi 2749
1049
Belgium

Francesca Campolongo

Europoean Commission - Joint Reserach Centre ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

Joint Research Center of the European Commission ( email )

Via E. Fermi 2749
1049
Belgium

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