Full paper available here.
Yen-Ting Hu and William Perraudin
In standard ratings-based models for analysing credit portfolios and pricing credit derivatives, it is assumed that defaults and recoveries are statistically independent. This paper presents evidence that aggregate quarterly default rates and recovery rates are, in fact, negatively correlated. Using Extreme Value Theory techniques, we show that the dependence affects the tail behaviour of total credit loss distributions and leads to higher VaR measures.
This version: February 2006
