Integrating Correlations

by Peter Bürgisser of the Universität Paterborn,
Alexandre Kurth of the Universität Basel,
Armin Wagner of UBS, and
Michael Wolf of UBS

July 1999

Abstract: How can a credit portfolio be diversified? Although for its tractability, CreditRisk+ fails to answer this vital question. By modelling the default correlation between industry sectors, we attempt to provide a solution. We first derive the probability generating function of the loss distribution for one industry sector following the CreditRisk+ approach. This is then generalized to several sectors to obtain the first two moments of the loss distribution, as well as a loss distribution consistent with the observed correlations between sectors.

Published in: RISK, Vol. 12, No. 7, (July 1999), pp. 57-60.

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