RT Journal Article
SR Electronic
T1 On Default Correlation
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 43
OP 54
DO 10.3905/jfi.2000.319253
VO 9
IS 4
A1 David X. Li
YR 2000
UL https://pm-research.com/content/9/4/43.abstract
AB This article studies the problem of default correlation. It introduces a random variable called “time-until-default” to denote the survival time of each defaultable entity or financial instrument, and defines the default correlation between two credit risks as the correlation coefficient between their survival times. The author explains why a copula function approach should be used to specify the joint distribution of survival times after marginal distributions of survival times are derived from market information, such as risky bond prices or asset swap spreads. He shows that the current approach to default correlation through asset correlation is equivalent to using a normal copula function. Numerical examples illustrate the use of copula functions in the valuation of some credit derivatives, such as credit default swaps and first-to-default contracts.