Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/40256
Authors: 
Erlenmaier, Ulrich
Gersbach, Hans
Year of Publication: 
2001
Series/Report no.: 
Research notes in economics & statistics 01-5
Abstract: 
Starting from the Merton framework for firm defaults, we provide the analytics and robustness of the relationship between default correlations. We show that loans with higher default probabilities will not only have higher variances but also higher correlations between loans. As a consequence, portfolio standard deviation can increase substantially when loan default probabilities rise. This result has two important implications. First, relative prices of loans with different default probabilities should reflect the differential impact on portfolio standard deviation. Second, the standard deviation of loan portfolios and of default rates, as well as the required economic capital will vary significantly over the business cycle.
Subjects: 
Credit portfolio management
Default correlations
Pricing of loans
Macroeconomic risk
Credit risk models
JEL: 
G11
G12
G21
G31
Document Type: 
Working Paper

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