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

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

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

September 12, 2005

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.

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