Modeling of Contagious Credit Events and Risk Analysis of Credit Portfolios

Abstract

We present a new model of the occurence of credit events such as rating changes and defaults for risk analyses of some portfolio credit derivatives. The framework of our model is based on a so-called top-down approach. Specifically, we first consider modeling the point process of each type of credit event in the whole economy using a self-exciting intensity process. Next, we characterize the point processes of credit events in the underlying sub-portfolio using random thinning processes specified by the distribution of credit ratings in the sub-portfolio. One of the main features of our model is that the model can capture credit risk contagion simultaneously among several credit portfolios. We present a credit event simulation algorithm based on our model and illustrate an application of the model to risk analyses of loan portfolios.

A random thinning model with a latent factor for improvement of top-down credit risk assessment

“…Several previous studies suggest some intensity models within top-down approach for assessing credit risks of large credit portfolios and/or pricing some credit portfolio derivatives. (Refer to [1][2][3][4][5]. )…”

“…As for random thinning, the most primitive thinning model, employed in [1] and [5], is specified by the size of sub-portfolios. In short, the most primitive thinning model allocates the universe portfolio intensity to a subportfolio according to the ratio of the number of constituents in the sub-portfolio to that of the universe portfolio.…”

Analysis of downgrade risk in credit portfolios with self-exciting intensity model

“…In this paper, we use a self-exciting process for the intensity model, where the term "self-exciting" means that the intensity increases when a event occurs. Several self-exciting type intensity models have been recently used in credit risk modeling to capture credit event clusters (see [2][3][4][5]). Credit event cluster is wellknown feature of credit events.…”

“…1 show that there are downgrade clusters, from 1998 to 2000, from 2001 to 2003 and from 2008 to 2010. Specifically, we use the self-exciting model proposed in [5].…”

“…Our thinning model is specified by some factors which represent characteristics of sub-portfolios. We adopt rating distribution for one of the factors to consider the size of credit portfolios, in common with the thinning model of [5].…”