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Confidence Sets for Asset Correlation

by Delphine Cassart of the Universite Libre de Bruxelles,
Carlos Castro of the Universite Libre de Bruxelles,
Ronny Langendries of Dexia SA, and
Thomas Alderweireld of Dexia SA

February 2007

Abstract: This paper addresses the estimation of confidence sets for asset correlation for credit risk assessment using rating transition data. Research on the estimation of asset correlation with rating transition data has focused on the point estimation of the correlation without giving any consideration with respect to the uncertainty around this point estimators. We obtain for both approaches, Standard Transition Matrix (STRM) and Directional Transition Matrix (DRTM), confidence intervals for the pairwise asset correlations. In both cases it is a regularity to find that the inferior bounds are most of the time negative while the superior bounds are most of the time positive, implying that most of the correlations are not significantly different from zero.

JEL Classification: G32, G33, C01.

Keywords: asset correlation, transition matrices, bootstrap.

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Related reading: CreditMetrics -- Technical Document