Keywords: financial risk, credit risk, default risk, reduced-form model, affine jump diffusions, large credit portfolios, risk assessment, modelling, simulation
Modelling the default risk in large credit portfolios
We propose a reduced-form model for credit risk in a multivariate setting. The default intensities are linear combinations of three independent affine jump-diffusion processes representing the intensities of general, sectoral and idiosyncratic credit events. The model can be efficiently calibrated to term structures of default probabilities and conditional probabilities of default given the occurrence of common credit events. We analyse the correlation of defaults and formulate an algorithm for the exact simulation of default scenarios.