Credit risk assessment of fixed income portfolios using explicit expressions
2014, Finance Research Letters, 11(3), pp.224-230
Credit risk
Expected loss
Correlation
Résumé
We propose a model to assess the credit risk features of fixed income portfolios assuming they can be characterized by two parameters: their default probability and their default correlation. We rely on explicit expressions to assess their credit risk and demonstrate the benefits of our approach in a complex leveraged structure example. We show that using expected loss as a proxy for credit risk is misleading as it does not capture the dispersion effects introduced by correlation. The implications of these findings are relevant for improving current risk management practices and for regulation purposes.