Dependence Modelling and Risk Analysis in a Joint Credit-Equity Framework

by Fredrik Backman

Institution: KTH Royal Institute of Technology
Year: 2015
Keywords: Natural Sciences; Mathematics; Mathematical Analysis; Naturvetenskap; Matematik; Matematisk analys; Teknologie masterexamen - Tillämpad matematik och beräkningsmatematik; Master of Science - Applied and Computational Mathematics; Mathematical Statistics; Matematisk statistik
Record ID: 1348395
Full text PDF: http://urn.kb.se/resolve?urn=urn:nbn:se:kth:diva-168154


This thesis is set in the intersection between separate types of financial markets, with emphasis on joint risk modelling. Relying on empirical findings pointing toward the ex- istence of dependence across equity and corporate debt markets, a simulation framework intended to capture this property is developed. A few different types of models form building blocks of the framework, including stochastic processes describing the evolution of equity and credit risk factors in continuous time, as well as a credit rating based model, providing a mechanism for imposing dependent credit migrations and defaults for firms participating in the market. A flexible modelling framework results, proving capable of generating dependence of varying strength and shape, across as well as within studied markets. Particular focus is given to the way markets interact in the tails of the distributions. By means of simulation, it is highlighted that dependence as produced by the model tends to spread asymmetrically with simultaneously extreme outcomes occurring more frequently in lower than in upper tails. Attempts to fit the model to observed market data featuring historical stock index and corporate bond index values are promising as both marginal distributions and dependence connecting the investigated asset types appear largely replicable, although we conclude further validation remains.