The role of correlation

In this second column on the potential pro-cyclicality of Basel II, David Rowe surveys recent research on the role of correlation between probability of default and recovery rates, as well as among default probabilities


There is a strong intuition that default rates (DR) and recovery rates (RR) will exhibit a negative correlation over time. In their July 2002 BIS working paper, Altman, Resti & Sironi examined this question using annual US non-investment-grade bond market data from 1982 through 2000.1 On a univariate basis, they found clear empirical evidence for such a negative correlation. The relationship appears to be non-linear, with RR dropping rapidly from around 55% when DR is in the range of 1.0% to 1.5

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Credit risk & modelling – Special report 2021

This Risk special report provides an insight on the challenges facing banks in measuring and mitigating credit risk in the current environment, and the strategies they are deploying to adapt to a more stringent regulatory approach.

The wild world of credit models

The Covid-19 pandemic has induced a kind of schizophrenia in loan-loss models. When the pandemic hit, banks overprovisioned for credit losses on the assumption that the economy would head south. But when government stimulus packages put wads of cash in…

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