Modelling Correlations in Credit Portfolio Risk

10 Pages Posted: 9 Feb 2007

See all articles by Bernd Rosenow

Bernd Rosenow

University of Cologne

Rafael Weissbach

University of Rostock

Frank Altrock

WestLB - Credit Risk Management

Date Written: June 15, 2006

Abstract

The risk of a credit portfolio depends crucially on correlations between latent covariates, for instance the probability of default (PD) in different economic sectors. Often, correlations have to be estimated from relatively short time series, and the resulting estimation error hinders the detection of a signal. We suggest a general method of parameter estimation which avoids in a controlled way the underestimation of correlation risk. Empirical evidence is presented how, in the framework of the CreditRisk+ model with integrated correlations, this method leads to an increased economic capital estimate. Thus, the limits of detecting the portfolio's diversification potential are adequately reflected.

Keywords: correlation, portfolio credit risk, random matrix theory, economic capital, value-at-risk, principal components

JEL Classification: C53, G11, G18, G32

Suggested Citation

Rosenow, Bernd and Weissbach, Rafael and Altrock, Frank, Modelling Correlations in Credit Portfolio Risk (June 15, 2006). Available at SSRN: https://ssrn.com/abstract=962344 or http://dx.doi.org/10.2139/ssrn.962344

Bernd Rosenow

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Rafael Weissbach (Contact Author)

University of Rostock ( email )

Ulmenstr. 69
Rostock, 18157
Germany
+49-(0)381-498-4428 (Phone)
+49-(0)381-498-4401 (Fax)

HOME PAGE: http://www.wiwi.uni-rostock.de/vwl/statistik/

Frank Altrock

WestLB - Credit Risk Management ( email )

Dusseldorf, 40217
Germany

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