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Credit Risk - A structural model with jumps and correlations

by Rudi Schäfer of Lund University,
Markus Sjölin of Lund University,
Andreas Sundin of Lund University,
Michal Wolanski of Lund University, and
Thomas Guhr of Lund University

December 2, 2008

Abstract: We set up a structural model to study credit risk for a portfolio containing several or many credit contracts. The model is based on a jump-diffusion process for the risk factors, i.e. for the company assets. We also include correlations between the companies. We discuss that models of this type have much in common with other problems in statistical physics and in the theory of complex systems. We study a simplified version of our model analytically. Furthermore, we perform extensive numerical simulations for the full model. The observables are the loss distribution of the credit portfolio, its moments and other quantities derived thereof. We compile detailed information about the parameter dependence of these observables. In the course of setting up and analyzing our model, we also give a review of credit risk modeling for a physics audience.

PACS numbers: 89.65.Gh, 05.40.Jc, 05.90.+m.

Keywords: credit risk, econophysics, stochastic processes.

Published in: Physica A: Statistical Mechanics and its Applications, Vol. 383, No. 2, (September 2007), pp. 533-569.

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