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A Cash Flow Based Corporate Credit Portfolio Analysis: A conditional independent default approach

by Hsien-hsing Liao of National Taiwan University, and
Tsung-kang Chen of National Taiwan University

May 20, 2006

Abstract: Most existing literatures on portfolio credit analysis are reduced from models. Few of them take into considerations of the dynamics of credit risk and are able to endogenously estimate the portfolio recovery (loss) rate. Within the framework of structural form credit models, this paper suggests combining a cash flow based credit model and a conditional independent default approach, such as the factor copula or the Fourier transform methods, to estimate the multi‐period credit risk of a corporate credit portfolio. The proposed approach differs from most existing literatures in that it considers the dynamics of risk structure and is able to endogenously estimate the portfolio recovery (loss) rate. We have exemplified how the proposed approach is applied to credit tranching and pricing of a cash funded CBO.

Keywords: Conditional independent default, Factor copula, Fourier transform method, Cash flow, Credit portfolio tranching and pricing, Risk dynamics.

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