Credit Risk Modeling: An Empirical Analysis on Pricing, Procyclicality and Dependence

Credit risk modeling has grown significantly over the past few years; driven by explosive growth in the credit derivatives market and more quantitatively sophisticated bank capital regulations under the upcoming Basel II Accord. Credit risk modeling relies mainly on three parameters,probability of default (PD),recovery rate (RR)and correlation.This book intends first to explain what is called the implied ?correlation skew?, and show that liquidity has some explanatory power on correlation . The second section analyses the relationship between credit default swap index spread and stock market returns and the third section provides a comprehensive analysis on the cyclicality of default rates,recovery rates and their dependence using financial data provided by Bank Call Reports from 1991 to 2005 for all US commercial banks with total assets greater than $300 millions. It shows that indeed, default rates and recovery rates are cyclical and inversely related. These findings have important implications in credit risk modeling for both the credit derivatives market and the new Basel II capital requirement proposed rule(LGD).

Dr Ayari is an Assistant Professor of Finance at Wagner College in New York, and has been consulting and conducting financial training for major financial institutions in the US, Europe and Asia.Dr. Ayari received his Ph.D. in Financial Economics from the City University of New York and his MS from the University of Paris XIII (France).