Dependent Defaults and Losses with Factor Copula Models
Dependence Modeling, Volume 5, Issue 1, Pages 375-399, 2017
29 Pages Posted: 17 Oct 2016 Last revised: 14 Jun 2019
Date Written: December 22, 2017
Abstract
We present a class of flexible and tractable static factor models for the term structure of joint default probabilities, the factor copula models. These high-dimensional models remain parsimonious with pair-copula constructions, and nest many standard models as special cases. The loss distribution of a portfolio of contingent claims can be exactly and efficiently computed when individual losses are discretely supported on a finite grid. Numerical examples study the key features affecting the loss distribution and multi-name credit derivatives prices. An empirical exercise illustrates the flexibility of our approach by fitting credit index tranche prices.
Keywords: credit portfolio, credit derivatives, discrete Fourier transform, factor copula, random loss, survival models
JEL Classification: C10, G12, G13
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