Dynamic frailties and credit portfolio modelling
Martin Delloye, Jean-David Fermanian and Mohammed Sbai estimate and discuss a reduced-form credit portfolio model in a proportional hazard framework. They propose an innovative method of generating flexible amounts of dependence between underlying defaults by introducing unobservable dynamic common explanatory variables, called dynamic frailties
Credit portfolio models are key tools for portfolio credit risk management, for economic capital calculations and for providing relevant inputs for Basel II regulatory requirements. Moreover, they can be used as pricing models for collateralised debt obligations (CDOs) and basket derivatives.
Intuitively, it is well understood that default probabilities and rating transitions are influenced by macroeconomic variables. Our goal is to model every rating transition simultaneously in a consistent
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