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Modelling Dynamic Portfolio Credit Risk

by Ebbe Rogge of the Imperial College of London & ABN AMRO Bank, and
Philipp J. Schönbucher of EHT Zurich

February 2003

Abstract: In this paper we present a model to price and hedge basket credit derivatives and collateralised loan obligation. Based upon the copula-approach by Schönbucher and Schubert (2001) the model allows a specification of the joint dynamics of credit spreads and default intensities, including a specification of the infection dynamics which cause credit spreads to widen at defaults of other obligors. Because of a high degree of analytical tractability, joint default and survival probabilities and also sensitivities can be given in closed-form which facilitates the development of hedging strategies based upon the model. The model uses a generalisation of the class of Archimedean copula functions which gives rise to more realistic credit spread dynamics than the Gaussian copula or the Student-t-copula which are usually chosen in practice. An example specification using Gamma-distributed factors is provided.

JEL Classification: G13.

Keywords: Portfolio Credit Risk Models, Copula functions, Credit Derivatives, First-to-Default Swap.

Download paper (379K PDF) 28 pages

* A Note on E. Rogge's and P. Schönbucher's Article "Modelling Dynamic Portfolio Credit Risk"
by Hans-Juergen Brasch, Dresdner Kleinwort Wasserstein
(153K PDF) -- 4 pages -- April 2, 2003