Estimating credit contagion in a standard-factor model

State-of-the-art credit risk portfolio models and the new Basel capital Accord consider only symmetric dependencies between borrowers in a portfolio, such as correlations. Recently, asymmetric dependencies have been introduced by Davis & Lo (2001), among others, but statistical estimation techniques and empirical evidence on contagion are still scarce. Daniel Rosch and Birker Winterfeldt provide a simple credit risk portfolio model extension to credit contagion and show how its parameters can be easily estimated and tested

Among the most important positions on the asset side of a financial institution's balance sheet are credit-risky securities, and a major task for risk managers and analytics is the appropriate modelling and forecasting of the inherent credit risk. Banks and other firms typically use credit risk models for this purpose, either supplied by vendors such as CreditMetrics or CreditRisk+ or internally developed (see, for example, Finger, 1998; Credit Suisse First Boston, 1997; or Bluhm, Overbeck &