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Risk Management in Corporate Loan Portfolio - Default Correlation

Fagerström, Sixten LU and Oddshammar, Gustav LU (2011) NEKM07 20111
Department of Economics
Abstract
Purpose:
The purpose of this paper is to estimate different industries’ default rate correlation over time. The intention is to observe if banks have any diversification opportunities in their corporate loan portfolio and to what extent this may disappear in stressful economic situations.

Methodology:
In this paper, the dynamic conditional correlation model is applied to analyze the default correlation structure over time in four Swedish corporate industries. The model applied has the characteristics of being equally flexible as univariate GARCH but not as complex as multivariate GARCH.

Results:
The findings of this paper suggest that the default correlation over time is fairly low which gives a bank some diversification... (More)
Purpose:
The purpose of this paper is to estimate different industries’ default rate correlation over time. The intention is to observe if banks have any diversification opportunities in their corporate loan portfolio and to what extent this may disappear in stressful economic situations.

Methodology:
In this paper, the dynamic conditional correlation model is applied to analyze the default correlation structure over time in four Swedish corporate industries. The model applied has the characteristics of being equally flexible as univariate GARCH but not as complex as multivariate GARCH.

Results:
The findings of this paper suggest that the default correlation over time is fairly low which gives a bank some diversification opportunity in their corporate loan portfolio. However, in times of economic distress, hence, when default rates are high, the correlations increase significantly. This is discussed to be very unfavorable from a risk management perspective since the correlations break down when needed the most. (Less)
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author
Fagerström, Sixten LU and Oddshammar, Gustav LU
supervisor
organization
course
NEKM07 20111
year
type
H2 - Master's Degree (Two Years)
subject
keywords
Dynamic conditional correlation, correlation, risk management, diversification, industry default rate
language
English
id
1975764
date added to LUP
2011-06-17 12:25:35
date last changed
2011-06-17 12:25:35
@misc{1975764,
  abstract     = {Purpose:
The purpose of this paper is to estimate different industries’ default rate correlation over time. The intention is to observe if banks have any diversification opportunities in their corporate loan portfolio and to what extent this may disappear in stressful economic situations. 

Methodology:
In this paper, the dynamic conditional correlation model is applied to analyze the default correlation structure over time in four Swedish corporate industries. The model applied has the characteristics of being equally flexible as univariate GARCH but not as complex as multivariate GARCH.   

Results:
The findings of this paper suggest that the default correlation over time is fairly low which gives a bank some diversification opportunity in their corporate loan portfolio. However, in times of economic distress, hence, when default rates are high, the correlations increase significantly. This is discussed to be very unfavorable from a risk management perspective since the correlations break down when needed the most.},
  author       = {Fagerström, Sixten and Oddshammar, Gustav},
  keyword      = {Dynamic conditional correlation,correlation,risk management,diversification,industry default rate},
  language     = {eng},
  note         = {Student Paper},
  title        = {Risk Management in Corporate Loan Portfolio - Default Correlation},
  year         = {2011},
}