Dependent defaults and losses with factor copula models

Abstract

We present a class of flexible and tractable static factor models for the term structure of joint default probabilities, the factor copula models. These high-dimensional models remain parsimonious with paircopula constructions, and nest many standard models as special cases. The loss distribution of a portfolio of contingent claims can be exactly and efficiently computed when individual losses are discretely supported on a finite grid. Numerical examples study the key features affecting the loss distribution and multi-name credit derivatives prices. An empirical exercise illustrates the flexibility of our approach by fitting credit index tranche prices.

Keywords

• credit portfolio
• credit derivatives
• discrete fourier transform
• factor copula
• random loss
• survival models
• 60e05
• 60e10
• 62h05
• 62h20
• 65t50
• 91g20
• 91g40
• 91g60