Modeling portfolio loss distribution under infectious defaults and immunization
Pricing of Securities
2026-01-22 v4
Abstract
We introduce a model for the loss distribution of a credit portfolio considering a contagion mechanism for the default of names which is the result of two independent components: an infection attempt generated by defaulting entities and a failed defence from healthy ones. We then propose an efficient recursive algorithm for the loss distribution. Then we extend the framework with more flexible distributions that integrate a contagion component and a systematic factor to better fit real-world data. Finally, we propose an empirical application in which we price synthetic CDO tranches of the iTraxx index, finding a good fit for multiple tranches.
Cite
@article{arxiv.2503.03306,
title = {Modeling portfolio loss distribution under infectious defaults and immunization},
author = {Gabriele Torri and Rosella Giacometti and Gianluca Farina},
journal= {arXiv preprint arXiv:2503.03306},
year = {2026}
}