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blaugranabhoy
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Posts: 26
Joined: November 26th, 2004, 4:36 pm

CLO default correlation

June 20th, 2011, 9:14 am

Hi,I'm trying to model a CLO structure as simply as possible and have taken the approach of modelling default probabilities as Bernoulli random variables, and then applying a correlation effect between these entities. On a very high level, I was wondering how this correlation is achieved. I haven't simulated binary variables previously, having only looked at equity/index simulation with correlation.Any help would be very welcome.
 
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Costeanu
Posts: 189
Joined: December 29th, 2008, 5:33 pm

CLO default correlation

June 23rd, 2011, 1:10 am

You should read about the "gaussian copula" credit model. It's quite famous, and it landed a place of honor on Paul's "Name and shame" list (some people think the gaussian copula caused the crisis). Observing a Bernoulli variable X (1 with p, 0 with 1-p) is the same as observing a normal variable Y and comparing it with a treshold N^{-1}(p). You could call the variable Y the gaussian driver of X. Now correlating a number of Bernoulli variables can be done by correlating their gaussian drivers. Best,V.
 
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blaugranabhoy
Topic Author
Posts: 26
Joined: November 26th, 2004, 4:36 pm

CLO default correlation

July 9th, 2011, 9:09 pm

Thanks Costeanu...hadn't checked boards for a while (so didn't see your response) but had used the approach you suggested for my model. Appreciate your response.
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