Dependent Defaults and Losses with Factor Copula Models

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.

Publication
Dependence Modeling

Related