Packham, Natalie Kalkbrener, Michael Overbeck, Ludger
Year of Publication:
Working Paper Series, Frankfurt School of Finance & Management 211
We investigate default probabilities and default correlations of Merton-type credit portfolio models in stress scenarios where a common risk factor is truncated. The analysis is performed in the class of elliptical distributions, a family of light-tailed to heavy-tailed distributions encompassing many distributions commonly found in financial modelling. It turns out that the asymptotic limit of default probabilities and default correlations depend on the max-domain of the elliptical distribution's mixing variable. In case the mixing variable is regularly varying, default probabilities are strictly smaller than 1 and default correlations are in (0; 1). Both can be expressed in terms of the Student t-distribution function. In the rapidly varying case, default probabilities are 1 and default correlations are 0. We compare our results to the tail dependence function and discuss implications for credit portfolio modelling.