Copula-Based Factor Model for Credit Risk Analysis

Meng-Jou Lu, Cathy Yi-Hsuan Chen & Karl Wolfgang Härdle
A standard quantitative method to access credit risk employs a factor model based on joint multi- variate normal distribution properties. By extending a one-factor Gaussian copula model to make a more accurate default forecast, this paper proposes to incorporate a state-dependent recovery rate into the con- ditional factor loading, and model them by sharing a unique common factor. The common factor governs the default rate and recovery rate simultaneously and creates their association implicitly. In...
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