CHAPTER 7
A Comparative Analysis
of Dependence Levels in
Intensity-Based and
Merton-Style Credit
Risk Models
Jean-David Fermanian and Mohammed Sbai
7.1 INTRODUCTION
In finance, especially for credit portfolio modeling, basket credit derivatives
(CDOs,n-thtodefault)pricingandhedging, thebuildingofanaccuratemea-
sure of the dependence between the underlying default events is becoming a
key-challenge (see Crouhy, Galai and Mark, 2002; Koyluoglu and Hickman,
1998, for a review of the current credit risk portfolio models). This new fron-
tier has induced a huge amount of literature for several years: Nyfeler (2000),
Frey and McNeil (2001), Schönbucher and Schubert (2001), Das, Geng and
Kapadia (2002), Elizalde (2003), Turnbull (2003), Yu (2003), among others.
There are mainly two usual approaches to simulate dependent default
events (Schlögl, 2002, for example): in the structural framework (Merton,
1974) a firm is falling into default when its asset value falls below its debt
level. In its multidimensional version, the default process of all the underly-
ing obligors is directly deduced from the joint process of asset values. Most
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