Consistent Assumptions for Modeling Credit Loss Correlations

Authors

Jan Dhaene, University of Amsterdam, and Katholieke Universiteit Leuven, Department of Applied Economics, University Leuven, NaamsestraatFollow
Marc J. Goovaerts, University of Amsterdam and at the Katholieke Univzrsiteit Leuven, Department of Applied Economics, University Leuven, Naamsestraat
Robert Koch, Fortis Central Risk ManagementFollow
Ruben Olieslagers, Fortis Central Risk ManagementFollow
Olivier Romijn, Fortis Central Risk Management
Steven Vanduffel, University of Amsterdam and at the Katholieke Univzrsiteit Leuven, Department of Applied Economics, University Leuven, NaamsestraatFollow

Date of this Version

2006

Document Type

Article

Citation

Journal of Actuarial Practice 13 (2006), pp. 165-174

Comments

Copyright 2006 Absalom Press

Abstract

We consider a single period portfolio of n dependent credit risks that are subject to default during the period. We show that using stochastic loss given default random variables in conjunction with default correlations can give rise to an inconsistent set of assumptions for estimating the variance of the portfolio loss. Two sets of consistent assumptions are provided, which it turns out, also provide bounds on the variance of the portfolio's loss. An example of an inconsistent set of assumptions is given.