Estimating Default and Recovery Rate Correlations

<span style="font-size: 10.0pt; mso-bidi-font-size: 12.0pt; font-family: "Times New Roman","serif"; mso-fareast-font-family: "Times New Roman"; mso-ansi-language: EN-US; mso-fareast-language: CS; mso-bidi-language: AR-SA;" lang="EN-US">The paper analyzes a two-factor credit risk model allowing to capture default and recovery rate variation, their mutual correlation, and dependence on various explanatory variables. At the same time, it allows computing analytically the unexpected credit loss. We propose and empirically implement estimation of the model based on aggregate and exposure level Moody’s default and recovery data. The results confirm existence of significantly positive default and recovery rate correlation. We empirically compare the unexpected loss estimates based on the reduced two-factor model with Monte Carlo simulation results, and with the current regulatory formula outputs. The results show a very good performance of the proposed analytical formula which could feasibly replace the current regulatory formula.</span>

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Year of publication:	2014
Authors:	Witzany, Jiri
Published in:	Bulletin of the Czech Econometric Society. - Česká ekonometrická společnost - CES. - Vol. 21.2014
Publisher:	Česká ekonometrická společnost - CES
Subject:	credit risk \| Basel II regulation \| default rates \| recovery rates \| correlation

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Extent:	text/html
Type of publication:	Article
Classification:	G20 - Financial Institutions and Services. General ; G28 - Government Policy and Regulation ; C51 - Model Construction and Estimation
Source:	RePEc - Research Papers in Economics

Persistent link: https://www.econbiz.de/10011098943