A Transformed Copula Function Approach to Credit Portfolio Modeling
- September 20, 3:00 - 4:30, Hill Center 552
We present a fundamental modification to the current popularly used copula function approach to the credit portfolio modeling introduced by Li (2000). The original approach simply uses a copula function to create a joint survival time distribution where individual survival time distribution is already risk neutralized, and given from a single name perspective. Based on Buhlmann's equilibrium pricing model (1980) under some assumptions on the aggregate risk or the multivariate Esscher and Wang transforms we find that the covariance between each individual risk and the market or aggregate risk should be included in the measure change. In the Gaussian copula model it is shown that we simply need to adjust the asset return by subtracting an item associated with the covariance risk.
This discovery allows us to theoretically link our credit portfolio modeling with our classical equity portfolio modeling in the CAPM setting. This can help us solve some practical problems we have been encountering in the credit portfolio modeling.
Dr. David Li, Managing Director, AIG Investments
David Li is currently the head of modeling and a managing director at AIG Investments. Previously he was the CRO at CICC, and head of credit derivative research and analytics at Barclays Capital and Citigroup. David is an early participant of credit derivative market, and his approach on credit curve construction and copula function method for credit portfolio modeling have been widely used in the industry. For background, see "The Formula that Killed Wall Street"