Default Correlation

From Open Risk Manual

Definition

Default Correlation denotes a measure of Default Dependency between different borrowers when considered as part of a Credit Portfolio. It measures the likelihood of Joint Default within the period of consideration.

Formula

Generic Default Correlation

The general formula for default correlation between two obligors is linking to the Joint Default probability:


\rho_{D} =  \frac{\mbox{JDP} - p_1 p_2}{\sqrt(p_1 (1 - p_1)  p_2 (1 - p_2))}

where p_i are is the Probability of Default of each obligor

From Default Rate Volatility

Given an estimate \sigma of Default Rate Volatility for a homogeneous credit portfolio, the average default correlation is[1]


\rho = \frac{N(\frac{\sigma^2}{\mu - \mu^2}) - 1}{N -1} \approx \frac{\sigma^2}{\mu - \mu^2}

See Also

References

  1. Credit Metrics Technical Document, 1997

Contributors to this article

» Wiki admin