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The Empirical Relation between Credit Quality, Recovery, and Correlation

Author

Listed:
  • Daniel Rosch

    (Leibniz Universitat Hannover)

  • Harald Scheule

    (Hong Kong Institute for Monetary Research, The University of Melbourne)

Abstract
The majority of industry credit portfolio risk models, as well as recent scientific results, are based on isolated modules for default probabilities and recoveries in the event of default. This paper shows that these common methods lead to various econometric drawbacks when the parameters are interpreted and aggregated for risk capital allocation and pricing purposes. This paper provides a top down approach in which individual credit risk parameters are derived analytically from a single model. This model allows for a i) dynamic, ii) consistent, and iii) unbiased modeling of credit portfolio risks. An empirical analysis provides evidence for the inferred relationship between credit quality, recovery and correlation.

Suggested Citation

  • Daniel Rosch & Harald Scheule, 2009. "The Empirical Relation between Credit Quality, Recovery, and Correlation," Working Papers 222009, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:222009
    as

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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Asset Value; Correlation; Credit Portfolio; Loss Given Default; Merton Model; Probability of Default; Recovery; Volatility;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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