Portfolio Risk and Dependence Modeling: Application of Factor and Copula Models

Abstract

We consider portfolio credit risk modeling with a focus on two approaches, the factor model, and the copula model. While other models have received greater scrutiny, both factor and cupola models have received little attention although these are appropriate for rating-based portfolio risk analysis. We review the two models with emphasis on the joint default probability. The copula function describes the dependence structure of a multivariate random variable. In this paper, it is used as a practical to simulation of generate portfolio with different copula, we only use Gaussian and t-copula case. And we generate portfolio default distributions and study the sensitivity of commonly used risk measures with respect to the approach in modeling the dependence structure of the portfolio.

Keywords

• Gaussian copula
• Factor model
• Copula model