2014/12/10 by Michel Denuit, Denuit, Michel, Anna Kiriliouk +3
Decision Sciences · Economics, Econometrics and Finance · Mathematics · #Credit Risk and Financial Regulations #Probability and Risk Models #Statistical Methods and Inference #q-fin.RM #q-fin.ST #stat.ME
paper · pdf · doi:10.48550/arxiv.1412.3230
arxiv created 2014/12/10 · arxiv updated 2014/12/11
Individual risk models need to capture possible correlations as failing to do so typically results in an underestimation of extreme quantiles of the aggregate loss. Such dependence modelling is particularly important for managing credit risk, for instance, where joint defaults are a major cause of concern. Often, the dependence between the individual loss occurrence indicators is driven by a small number of unobservable factors. Conditional loss probabilities are then expressed as monotone functions of linear combinations of these hidden factors. However, combining the factors in a linear way allows for some compensation between them. Such diversification effects are not always desirable and this is why the present work proposes a new model replacing linear combinations with maxima. These max-factor models give more insight into which of the factors is dominant.