Creditrisk(+) Model With Dependent Risk Factors

The CreditRisk(+) model is widely used in industry for computing the loss of a credit portfolio. The standard CreditRisk(+) model assumes independence among a set of common risk factors, a simplified assumption that leads to computational ease. In this article, we propose to model the common risk factors by a class of multivariate extreme copulas as a generalization of bivariate Frechet copulas. Further we present a conditional compound Poisson model to approximate the credit portfolio and provide a cost-efficient recursive algorithm to calculate the loss distribution. The new model is more flexible than the standard model, with computational advantages compared to other dependence models of risk factors.