Extreme Portfolio Loss Correlations in Credit Risk

The stability of the financial system is associated with systemic risk factors such as the concurrent default of numerous small obligors. Hence, it is of utmost importance to study the mutual dependence of losses for different creditors in the case of large, overlapping credit portfolios. We analyti...

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Main Authors: Andreas Mühlbacher, Thomas Guhr
Format: Article
Language:English
Published: MDPI AG 2018-07-01
Series:Risks
Subjects:
Online Access:http://www.mdpi.com/2227-9091/6/3/72
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spelling doaj-91d92432eea84bb8b81a46ce2b64117e2020-11-25T00:07:07ZengMDPI AGRisks2227-90912018-07-01637210.3390/risks6030072risks6030072Extreme Portfolio Loss Correlations in Credit RiskAndreas Mühlbacher0Thomas Guhr1Fakultät für Physik, Universität Duisburg-Essen, Lotharstraße 1, 47048 Duisburg, GermanyFakultät für Physik, Universität Duisburg-Essen, Lotharstraße 1, 47048 Duisburg, GermanyThe stability of the financial system is associated with systemic risk factors such as the concurrent default of numerous small obligors. Hence, it is of utmost importance to study the mutual dependence of losses for different creditors in the case of large, overlapping credit portfolios. We analytically calculate the multivariate joint loss distribution of several credit portfolios on a non-stationary market. To take fluctuating asset correlations into account, we use an random matrix approach which preserves, as a much appreciated side effect, analytical tractability and drastically reduces the number of parameters. We show that, for two disjoint credit portfolios, diversification does not work in a correlated market. Additionally, we find large concurrent portfolio losses to be rather likely. We show that significant correlations of the losses emerge not only for large portfolios with thousands of credit contracts, but also for small portfolios consisting of a few credit contracts only. Furthermore, we include subordination levels, which were established in collateralized debt obligations to protect the more senior tranches from high losses. We analytically corroborate the observation that an extreme loss of the subordinated creditor is likely to also yield a large loss of the senior creditor.http://www.mdpi.com/2227-9091/6/3/72portfolio credit risksystemic riskdiversificationportfolio loss correlationcollateralized debt obligationsnon-stationarity
collection DOAJ
language English
format Article
sources DOAJ
author Andreas Mühlbacher
Thomas Guhr
spellingShingle Andreas Mühlbacher
Thomas Guhr
Extreme Portfolio Loss Correlations in Credit Risk
Risks
portfolio credit risk
systemic risk
diversification
portfolio loss correlation
collateralized debt obligations
non-stationarity
author_facet Andreas Mühlbacher
Thomas Guhr
author_sort Andreas Mühlbacher
title Extreme Portfolio Loss Correlations in Credit Risk
title_short Extreme Portfolio Loss Correlations in Credit Risk
title_full Extreme Portfolio Loss Correlations in Credit Risk
title_fullStr Extreme Portfolio Loss Correlations in Credit Risk
title_full_unstemmed Extreme Portfolio Loss Correlations in Credit Risk
title_sort extreme portfolio loss correlations in credit risk
publisher MDPI AG
series Risks
issn 2227-9091
publishDate 2018-07-01
description The stability of the financial system is associated with systemic risk factors such as the concurrent default of numerous small obligors. Hence, it is of utmost importance to study the mutual dependence of losses for different creditors in the case of large, overlapping credit portfolios. We analytically calculate the multivariate joint loss distribution of several credit portfolios on a non-stationary market. To take fluctuating asset correlations into account, we use an random matrix approach which preserves, as a much appreciated side effect, analytical tractability and drastically reduces the number of parameters. We show that, for two disjoint credit portfolios, diversification does not work in a correlated market. Additionally, we find large concurrent portfolio losses to be rather likely. We show that significant correlations of the losses emerge not only for large portfolios with thousands of credit contracts, but also for small portfolios consisting of a few credit contracts only. Furthermore, we include subordination levels, which were established in collateralized debt obligations to protect the more senior tranches from high losses. We analytically corroborate the observation that an extreme loss of the subordinated creditor is likely to also yield a large loss of the senior creditor.
topic portfolio credit risk
systemic risk
diversification
portfolio loss correlation
collateralized debt obligations
non-stationarity
url http://www.mdpi.com/2227-9091/6/3/72
work_keys_str_mv AT andreasmuhlbacher extremeportfoliolosscorrelationsincreditrisk
AT thomasguhr extremeportfoliolosscorrelationsincreditrisk
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