Journal of Credit Risk

Risk.net

Two models of stochastic loss given default

Simone Farinelli and Mykhaylo Shkolnikov

ABSTRACT

We propose two structural models for stochastic loss given default that allow the credit losses of a portfolio of defaultable financial instruments to be modeled. The credit losses are integrated into a structural model of default events accounting for correlations between the default events and the associated losses. We show how the models can be calibrated and analyze the impact of correlations between the occurrences of defaults and recoveries by testing our models for a representative sample portfolio.

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