# C.01.Hull 23

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 Author: Exam9_2012 ID: 137221 Filename: C.01.Hull 23 Updated: 2012-05-09 16:21:06 Tags: Credit Risk Folders: Description: Credit Risk Show Answers:

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1. Default probabilities
• unconditional prob of def = prob that exist at 0 will default
• def intensity / hazard rate = prob def given no default at t
• prod def by t =
2. Recovery rate
• % pmt recovered in case of default
• negatively correlated w default rates
3. Estimating def prob from bd price
• assumption: only reason why P > risk-free P is default
• approximation:
• exp loss from def = P - risk-free P
• set PV(exp loss) = PV(rf value) - PV(recovery)
• more realistic: def more often, constant intensity, diff Q patterns
4. Estimating def prob from equity price (Merton's Model)
• and
• p(default) = N(-d2)
5. Credit risk mitigation
• netting: default on all or nothing
• collateralization: revalue contract and ask for more collateral if exceeds threshold (-) if fin trouble won't post
• downgrade triggers: if cr rating falls below threshold, close contract (-) protects small jumps only (-) only works well if counterparty has few outstanding contracts with that clause
6. Gaussian Copula model for time to default
• cpies in same region affected by similar econ events
• def from one cpy may cause other def
• assumption: all cpies will eventually default
• xi=N-1[Qi(ti)] -> f(x1,x2) bivariate normal
7. Credit Metrics
• cr VaR of Y at x% conf lvl = x% conf that cr loss < Y
• Cr Metrics: program that derives prob dist of cr loss
• (+) accounts for impact of downgrage
• (+) can incorporate cr mitigation clauses
• (-) computationally time intensive

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