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Dynamic Frailties and Credit Portfolio Modelling

by Martin Delloye of Ixis-CIB & BNP Paribas,
Jean-David Fermanian of Ixis-CIB, and
Mohammed Sbai of Ixis-CIB & Ecole Nationale des Ponts et Chaussées

October 2006

Abstract: We define a reduced-form credit portfolio model. Every rating transition is viewed as the result of independent competing risks, conditionally on a set of observable explanatory variables and under the proportional hazards assumption. The Standard and Poor's historical database CreditPro provides an estimation in continuous time. To allow more strong dependence levels between rating transitions for all the firms, we extend the model by adding a component of heterogeneity (a frailty), that is defined as an unobservable random process. Estimation issues and some empirical results are provided in the latter case.

JEL Classification: G10, G11, G12.

Keywords: Credit risk, dependence, reduced-form, frailty.

Published in: RISK, Vol. 19, No. 10, (October 2006), pp. 100-105.

Previously titled: Estimation of a Reduced-Form Credit Portfolio Model and Extensions to Dynamic Frailties

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