Related papers: The Impossible Trio in CDO Modeling
This paper investigates the finite horizon risk-sensitive portfolio optimization in a regime-switching credit market with physical and information-induced default contagion. It is assumed that the underlying regime-switching process has…
We show how to restructure the counterparty risk faced by the originator of a securitization or covered bond arising from an interest rate hedging swap assisted by a "one-way" collateral agreement. This risk emerges when the swap is…
We consider the problem of forecasting debt recovery from large portfolios of non-performing unsecured consumer loans under management. The state of the art in industry is to use stochastic processes to approximately model payment behaviour…
The risk of a credit portfolio depends crucially on correlations between the probability of default (PD) in different economic sectors. Often, PD correlations have to be estimated from relatively short time series of default rates, and the…
We introduce an arbitrage-free framework for robust valuation adjustments. An investor trades a credit default swap portfolio with a risky counterparty, and hedges credit risk by taking a position in defaultable bonds. The investor does not…
This paper presents a convenient framework for modeling default process and pricing derivative securities involving credit risk. The framework provides an integrated view of credit valuation adjustment by linking distance-to-default,…
A problem of optimal debt management is modeled as a noncooperative game between a borrower and a pool of lenders, in infinite time horizon with exponential discount. The yearly income of the borrower is governed by a stochastic process.…
In this three-part series of papers, we argue that the conventional spread measures are not well defined for credit-risky bonds and introduce a set of credit term structures which correct for the biases associated with the strippable cash…
Credit Valuation Adjustment is a balance sheet item which is nowadays subject to active risk management by specialized traders. However, one of the most important risk factors, which is the vector of default intensities of the counterparty,…
In a series of recent papers, Damiano Brigo, Andrea Pallavicini, and co-authors have shown that the value of a contract in a Credit Valuation Adjustment (CVA) setting, being the sum of the cash flows, can be represented as a solution of a…
We propose a unified structural credit risk model incorporating both insolvency and illiquidity risks, in order to investigate how a firm's default probability depends on the liquidity risk associated with its financing structure. We assume…
The optimization of large portfolios displays an inherent instability to estimation error. This poses a fundamental problem, because solutions that are not stable under sample fluctuations may look optimal for a given sample, but are, in…
In recent years research on credit risk modelling has mainly focused on default probabilities. Recovery rates are usually modelled independently, quite often they are even assumed constant. Then, however, the structural connection between…
We give a comprehensive review of credit term structure modeling methodologies. The conventional approach to modeling credit term structure is summarized and shown to be equivalent to a particular type of the reduced form credit risk model,…
According to theoretical models of valuing risky corporate securities, risk of default is primary component in overall yield spread. However, sizable empirical literature considers it otherwise by giving more importance to non-default risk…
This study deals with the pricing and hedging of single-tranche collateralized debt obligations (STCDOs). We specify an affine two-factor model in which a catastrophic risk component is incorporated. Apart from being analytically tractable,…
Distributionally Robust Optimization (DRO) is a worst-case approach to decision making when there is model uncertainty. It is also well known that for certain uncertainty sets, DRO is approximated by a regularized nominal problem. We show…
We consider a structural stochastic volatility model for the loss from a large portfolio of credit risky assets. Both the asset value and the volatility processes are correlated through systemic Brownian motions, with default determined by…
Based on supermodularity ordering properties, we show that convex risk measures of credit losses are nondecreasing w.r.t. credit-credit and, in a wrong-way risk setup, credit-market, covariances of elliptically distributed latent factors.…
We propose a numerical recipe for risk evaluation defined by a backward stochastic differential equation. Using dual representation of the risk measure, we convert the risk valuation to a stochastic control problem where the control is a…