Practice Leader, ERM and Structured Products Advisory, Promontory Financial, New York
Credit risk has always constituted by far the biggest risk for many large banks, almost all medium and small banks and thrifts. Credit risk is progressively becoming more important for insurance companies, mutual funds and hedge funds. In view of this, it has been puzzling that most well-known academic departments of finance and economics do not offer much course work on credit risk. There are also relatively few articles on transaction and portfolio credit risk in the top academic journals in finance and economics. However, in recent years, research in credit risk has become a growing field of endeavor amongst both finance practitioners and academics.
The number and size of new credit products are growing rapidly in all developed capital markets of the world. Therefore, The Journal of Credit Risk fills a void, is timely and covers an important and vast area of interest in finance. The Journal of Credit Risk has been published for the last two calendar years, during which it has disseminated research papers and discussions on various aspects of portfolio credit risk and pricing of credit products. It has been my privilege to be associated with the journal from the beginning as a member of the editorial board.
As Editor-in-Chief now, I hope, with the help of all the readers, contributors and the editorial board, to continue the tradition of publishing quality articles that enhance the knowledge of readers and to increase the circulation of the journal.
While all credit risk-related articles are welcome, as always, I would like to especially solicit articles on loss given default, which is an element that is often oversimplified in otherwise sophisticated modeling of credit products. I would also like to solicit conceptual and practical articles on active credit portfolio management.
In this issue we present four full-length research papers. In the first paper, “Affine Markov chain model of multifirm credit migration”, T. R. Hurd and A. Kuznetsov extend the basic intensity-based approach common to credit risk modeling to multistate credit migration. The authors do this by generalizing the intensity process to a finite-state Markov chain where the states represent credit ratings or discretized distance to default and go on to derive several extensions that represent realistic product or market characteristics. The second paper, “Beyond the Gaussian copula: stochastic and local correlation”, by X. Burtschell, J. Gregory and J.-P. Laurent, presents a stochastic correlation model for pricing CDO tranches. The authors derive the probability-generating function and semi-analytical expression for CDO tranche premiums and provide market fits to their model results. In the third paper, “Fitting the CDO correlation skew: a tractable structural jump–diffusion model”, Søren Willemann presents a different model for the valuation of CDO tranches and provides calibration of the model to market observations. The jump–diffusion specification of firm value is used to bring in correlations from two sources: diffusion of asset values and common jumps in asset values. In the fourth paper, “Hedging of basket credit derivatives in credit default swap market”, Tomasz R. Bielecki, Monique Jeanblanc and Marek Rutkowski present a reduced-form framework for depicting credit risk in all default swaps. Under deterministic default intensity, the authors derive closedform results for valuation of credit default swaps. They also show that a general basket claim can be viewed as a sequence of conditional first-to-default claims and provide results for hedging any basket claim with single-name CDSs.