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Implied asset value distributions

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  • Gunter Loffler

Abstract

In portfolio credit risk models, correlated credit events are often modelled by means of correlated latent variables. The latent variables are interpreted as the firms' asset values, and assumed to follow a normal distribution. A procedure is described that uses the information embodied in rating transition matrices to infer the shape of the latent variable distribution. Applying the approach to transition matrices of different origin yields consistent results. Compared to the normal distribution, the implied asset value distributions are fat-tailed, leading to a substantial increase of portfolio credit risk relative to the one under normality. The results are thus highly relevant for the design of credit risk measurement systems.

Suggested Citation

  • Gunter Loffler, 2004. "Implied asset value distributions," Applied Financial Economics, Taylor & Francis Journals, vol. 14(12), pages 875-883.
    • Handle: RePEc:taf:apfiec:v:14:y:2004:i:12:p:875-883
    DOI: 10.1080/09603100410001685312
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    References listed on IDEAS

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