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The Journal of Fixed Income

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Primary Article

Integrating Market and Credit Risk Using a Simplified Frailty Default Correlation Structure

Cheng-Kun Kuo and Chih-Wei Lee
The Journal of Fixed Income Summer 2007, 17 (1) 48-58; DOI: https://doi.org/10.3905/jfi.2007.688965
Cheng-Kun Kuo
A professor of finance at Department of International Business, National Taiwan University in Taipei, Taiwan.
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  • For correspondence: chengkuo@management.ntu.edu.tw
Chih-Wei Lee
An assistant professor of finance at Department of Finance, National Taipei College of the Business in Taipei, Taiwan.
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  • For correspondence: arthurse@webmail.ntcb.edu.tw
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Abstract

This article adopts a simplified approach to assess the correlation structure of credit risk. The approach could significantly reduce the numbers of estimated parameters in credit risk measurement. Thus it provides a simple way to integrate market risk smoothly that leads to a unified framework for computing fixed-income portfolio Value at Risk (VaR). Furthermore, based on recent research findings that frailty factors could induce a large estimated increase in default clustering, we also consider frailty variables in our integrated model. Using a portfolio as illustration, it is shown that the traditional approach where the correlation of market and credit risk is not considered, or frailty is not accounted for, may under-estimate VaR.

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The Journal of Fixed Income
Vol. 17, Issue 1
Summer 2007
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Integrating Market and Credit Risk Using a Simplified Frailty Default Correlation Structure
Cheng-Kun Kuo, Chih-Wei Lee
The Journal of Fixed Income Jun 2007, 17 (1) 48-58; DOI: 10.3905/jfi.2007.688965

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Integrating Market and Credit Risk Using a Simplified Frailty Default Correlation Structure
Cheng-Kun Kuo, Chih-Wei Lee
The Journal of Fixed Income Jun 2007, 17 (1) 48-58; DOI: 10.3905/jfi.2007.688965
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