Effects of Integrating Market Risk into Credit Portfolio Models
In this chapter, the effect of integrating interest rate and credit spread risk into the CreditMetrics framework14 is analyzed for a portfolio of defaultable zero coupon bonds. In the base case, this portfolio is assumed to be homogeneous. At the risk horizon, the value of a non-defaulted bond is determined by discounting its face value with the risk-free spot yield and the rating-specific credit spread corresponding to the simulated asset return. Risk-free spot yields and rating-specific credit spreads are assumed to be correlated. Furthermore, transition risk is correlated with the interest rate and credit spread risk. If a bond defaults before the risk horizon, its value is set equal to an independent beta-distributed fraction of a risk-free, but otherwise identical, zero coupon bond.
KeywordsInterest Rate Risk Measure Credit Risk Asset Return Credit Spread
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- 35.See Kiesel, Perraudin and Taylor (2003, p. 23, table 4, matrix ‘Three-year maturity, Jarrow-Lando-Turnbull recovery’, row ‘BBB’).Google Scholar