Correlations under Stress
Empirically, correlations between equities increase in bear markets. However, in the industry-standard, (one-factor) Gaussian credit-risk model for a single sector, the tail correlations between equities converge to zero in a market downturn. This introduces significant model risk in portfolio credi...
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| Veröffentlicht in: | International Review of Applied Financial Issues and Economics 2010-04, Vol.2 (2), p.248-271 |
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| container_title | International Review of Applied Financial Issues and Economics |
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| creator | Iscoe, Ian Bae, Taehan |
| description | Empirically, correlations between equities increase in bear markets. However, in the industry-standard, (one-factor) Gaussian credit-risk model for a single sector, the tail correlations between equities converge to zero in a market downturn. This introduces significant model risk in portfolio credit-risk management, due to the resulting underestimation of losses from correlated defaults or downgrades in severe market-downturn scenarios. An alternative model is proposed, in which the systemic factor undergoes exponential, downward jumps and for which the conditional correlations increase to a certain level under stress. An example is given using Dow Jones US sector index returns. |
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| identifier | ISSN: 9210-1737 |
| ispartof | International Review of Applied Financial Issues and Economics, 2010-04, Vol.2 (2), p.248-271 |
| issn | 9210-1737 |
| language | eng |
| recordid | cdi_ceeol_journals_199316 |
| source | EZB-FREE-00999 freely available EZB journals |
| subjects | Bear markets Correlation analysis Credit risk Economy Normal distribution Rates of return Studies |
| title | Correlations under Stress |
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