The analysis of credit risk in a portfolio requires measures of dependency across assets. Individual spreads in the pricing world, probabilities of default (PDs) and loss-given-default in the risk universe, management world, are important but insufficient to determine the price/risk of multiname products and their entire distribution of losses.
Because the diversification effects are related to dependency, neither the price of a portfolio can be defined as a linear combination of the price of its underlying components, nor its loss distribution can be the sum of the distributions of individual losses.
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Posted in Finance, Loan
Univariate pricing is a key component to the pricing of structured credit vehicles. To date, credit is still very much an incomplete market. In addition, it is usually difficult to use a simple diffusion setup to model its dynamic, as default risk is usually perceived as an unexpected event, i.e., a jump. An incomplete market and the presence of jumps make the credit space a difficult market, where it is not always easy to derive prices from the cost of related replicating (hedging) strategies/portfolios.
Due to these characteristics, market participants have been trying hard to make the most of two alternatives:
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Posted in Finance, Loan