An Alternative Way of Estimating Asset Values and Asset Value Correlations

Abstract

In this article, the author suggests a new way of modeling the dynamics of a firm’s asset value and discusses how it could be useful in the computation of asset value correlations in multivariate credit risk models. The method relies on credit spreads from the credit default swap market, and by combining these spreads with stock prices and leverage ratios, the author shows how one can construct a proxy for the asset value. This proxy is then used to calculate asset value correlations among a group of major European banks selected from the stress test conducted by the Committee of European Banking Supervisors in 2010. The asset correlations are presented as a function of bank size, default risk, and geographic location.