Maximum likelihood estimate of default correlations
Estimating asset correlations is difficult in practice since there is little available data andmany parameters have to be found. Paul Demey, Jean-Frédéric Jouanin, Céline Roget andThierry Roncalli present a tractable version of the multi-factor Merton model in which firmsare sorted into homogeneous risk classes. They derive a simplified maximum likelihoodapproach that provides estimates in a reasonable computational time. As an application ofthis methodology, industrial sector correlations are estimated from S&P’s data
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