Copulas and dependence models in credit risk: diffusions versus jumps

Luciano, Elisa (2006): Copulas and dependence models in credit risk: diffusions versus jumps. Published in: Statistica Applicata , Vol. 18, No. 4 (2006): pp. 573-588.

Abstract

The most common approach for default dependence modelling is at present copula functions. Within this framework, the paper examines factor copulas, which are the industry standard, together with their latest development, namely the incorporation of sudden jumps to default instead of a pure diffusive behavior. The impact of jumps on default dependence - through factor copulas - has not been fully explored yet. Our novel contribution consists in showing that modelling default arrival through a pure jump asset process does matter, even when the copula choice is the standard, factor one, and the correlation is calibrated so as to match the diffusive and non diffusive case. An example from the credit derivative market is discussed.

• Item Type: MPRA Paper
• Language: English
• Keywords: credit risk, correlated defaults, structural models, Lévy processes, copula functions, factor copula
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C10 - General; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C30 - General; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C60 - General; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

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