Economy – Quantitative Finance – Risk Management
We apply a Coupled Markov Chain approach to model rating transitions and thereby default probabilities of companies. We estimate parameters by applying a maximum likelihood estimation using a large set of historical ratings. Given the parameters the model can be used to simulate scenarios for joint rating changes of a set of companies, enabling the use of contemporary risk management techniques. We obtain scenarios for the payment streams generated by CDX contracts and portfolios of such contracts. This allows for assessing the risk of the current position held and design portfolios which are optimal relative to the risk preferences of the investor.
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