Credit Risk

<body stylesrc="../_private/template_title.htm" topmargin="10" leftmargin="10" bgcolor="#FFFFFF" link="#333366" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table2"> <tr> <td width="780"> <div align="center"> <table border="0" cellpadding="5" cellspacing="0" height="206" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table3"> <tr> <td align="right" height="198" width="1%"> <p align="left"> <img border="0" src="../images/book_duffie_singleton_2003).gif" width="133" height="200"></td> <td valign="top" align="left" height="198"> <table border="0" cellspacing="1" style="border-collapse: collapse" bordercolor="#111111" cellpadding="0" id="table4"> <tr> <td colspan="3" width="0%"> <p class="book_title">Credit Risk<br> <font size="3">Pricing, Measurement, and Management</font></td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"><img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> <td width="52%" class="book_details_tags" valign="top" height="144" align="left" rowspan="9"> <map name="FPMap2"> <area href="../main/ratings.htm" shape="rect" coords="73, 0, 164, 33"> </map> <img border="0" src="../images_title/duffie53.gif" usemap="#FPMap2" width="207" height="158"></td> <td class="book_details" height="112" align="center" width="50%" rowspan="7"> <img border="0" src="../images/best_of_award_2003.gif" width="125" height="109"></td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> <td class="book_details" height="32" align="center" width="50%" rowspan="2"> </td> </tr> <tr> <td width="1%" class="book_details_tags" valign="top" height="16" align="left"> </td> </tr> </table> </td> </tr> </table> </div> <div align="center"> <center> <table border="0" cellpadding="10" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="468" id="table5"> <tr> <td> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td></tr> </table> </center> </div> <table border="0" cellpadding="5" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table6"> <tr> <td width="45%" valign="top"> <p class="body">Credit risk modeling is essential for valuing instruments such as credit derivatives, collateralized debt obligations (CDOs), or even defaultable OTC derivatives. It can play an integral role in credit analysis. It also underlies capital calculations for credit risk.</p> <p class="body">While techniques vary, the general approach is to define some default model that assesses default probabilities for single obligors. This can be extended to multiple obligors by incorporating some correlation framework.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="125" align="left" id="table7"> <tr> <td width="120"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td><td width="5"> </td> </tr> </table> <p class="body">Standard default models generally fall into two categories:</p> <p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10">structural (asset value) models,</p> <p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10">intensity (reduced-form) models.</p> <p class="body">Darrell Duffie and Ken Singleton performed much of the pioneering work in intensity models. With this book, they provide an introduction to credit risk modeling with an emphasis on intensity models. It is an accessible and authoritative book.</p> <p class="body">The book has 13 chapters. The first five discuss credit risk measurement and start to introduce concepts that are useful in the pricing of credit risk—including the notion of default intensity. This discussion culminates in Chapter 5, which formalizes asset value and intensity models. Chapters 7 through 9 apply these to the pricing of:</p> <p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10">corporate and sovereign debt, </p> <p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10">credit swaps, and </p> <p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10">callable and convertible debt.</p> <p class="body">Of these, Chapter 7 is very nice. It offers a discussion of recovery modeling that is a practical alternative to Schönbucher's (<a href="../titles/schonbucher_p_(2003).htm">2003</a>) more theoretical treatment of the same material.</p> <p class="body">The discussion of convertible debt is excellent, covering issues well beyond just the credit risk of the instruments.</p> <p class="body">Chapter 10 considers the modeling of correlated defaults. Results are applied in the subsequent chapter to the pricing of CDOs. This material could be stronger. Modeling correlations is one area where structural models clearly outperform intensity models, but the authors continue to emphasize intensity approaches. The chapter on CDOs offers some nice qualitative discussions of CDO risks, but pricing is covered only in passing.</p> <p class="body">Chapter 12 is an excellent chapter on the potential credit exposure of OTC derivatives and models for adjusting derivatives prices to reflect this risk. The discussions are detailed. The models are well presented and are supported by worked examples.</p> <p class="body">A final chapter discusses the integration of market and credit risk measurement.</p> <p class="body">This book is not overly technical. The authors have a reputation for writing impenetrable papers on finance, but they have been careful to make this book accessible to any reader with a firm understanding of financial engineering and risk neutral valuation. A downside of this is the fact that results are sometimes presented as valid subject to unnamed "technical" conditions. Other times, readers are referred to the literature for details.</p> <p class="body">The flow of topics is not as cohesive as one might like. This seems to reflect as much the authors own research interests as any careful planning of a book. A unifying theme is the use of intensity models, but chapters on empirical research, convertible debt, potential credit exposure, and the integration of market and credit risk are tangential.</p> <p class="body">How does the book compare to Schönbucher's (<a href="../titles/schonbucher_p_(2003).htm">2003</a>) bible on credit derivatives pricing? Its mathematics is more accessible, so readers might want to read Duffie and Singleton to familiarize themselves with intensity models before proceeding to Schönbucher. On the other hand, Duffie and Singleton is somewhat parochial in their focus on intensity models. Schönbucher is more universal. It is the sort of well-integrated book that you read from beginning to end—it is credit derivatives pricing through and through. Duffie and Singleton is a book that, after you have read certain "core" chapters, you then pick and choose among the remaining chapters that interest you. While much of its discussion focuses on credit derivatives pricing, other credit-related topics are also discussed.</p> </td> <td width="55%" valign="top" class="body" rowspan="2"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td width="100%" bgcolor="#333366"> <p class="header_yellow" align="center">Contents</td> </tr> <tr> <td width="100%" class="explanatory_text"> <table border="1" cellpadding="2" cellspacing="0" style="border-collapse: collapse" bordercolor="#CCCCFF" bgcolor="#CCCCFF" width="100%" id="table9"> <tr> <td class="contents_expanded"> <p class="contents_expanded"><b>1 Introduction<br> </b>A Brief Zoology of Risks<br> Organization of Topics</p> <p class="contents_expanded"><b>2 Economic Principles of Risk Management<br> </b>What Types of Risk Count Most?<br> Economics of Market Risk<br> Economic Principles of Credit Risk<br> Risk Measurement<br> Measuring Credit Risk</p> <p class="contents_expanded"><b>3 Default Arrival: Historical Patterns and </b>Statistical Models<br> Structural Models of Default Probability<br> From Theory to Practice: Using Distance to Default to Predict Default<br> Default Intensity<br> Examples of Intensity Models<br> Default-Time Simulation<br> Statistical Prediction of Bankruptcy</p> <p class="contents_expanded"><b>4 Ratings Transitions: Historical Patterns and </b>Statistical Models<br> Average Transition Frequencies<br> Ratings Risk and the Business Cycle<br> Ratings Transitions and Aging<br> Ordered Probits of Ratings<br> Ratings as Markov Chains</p> <p class="contents_expanded"><b>5 Conceptual Approaches to Valuation of Default Risk<br> </b>Risk-Neutral versus Actual Probabilities<br> Reduced-Form Pricing<br> Structural Models<br> Comparisons of Model-Implied Spreads<br> From Actual to Risk-Neutral Intensities</p> <p class="contents_expanded"><b>6 Pricing Corporate and Sovereign Bonds<br> </b>Uncertain Recovery<br> Reduced-Form Pricing with Recovery<br> Ratings-Based Models of Credit Spreads<br> Pricing Sovereign Bonds</p> <p class="contents_expanded"><b>7 Empirical Models of Defaultable Bond Spreads<br> </b>Credit Spreads and Economic Activity<br> Reference Curves for Spreads<br> Parametric Reduced-Form Models<br> Estimating Structural Models<br> Parametric Models of Sovereign Spreads</p> <p class="contents_expanded"><b>8 Credit Swaps<br> </b>Other Credit Derivatives<br> The Basic Credit Swap<br> Simple Credit-Swap Spreads<br> Model-Based CDS Rates<br> The Role of Asset Swaps</p> <p class="contents_expanded"><b>9 Optional Credit Pricing<br> </b>Spread Options<br> Callable and Convertible Corporate Debt<br> A Simple Convertible Bond Pricing Model</p> <p class="contents_expanded"><b>10 Correlated Defaults<br> </b>Alternative Approaches to Correlation<br> CreditMetrics Correlated Defaults<br> Correlated Default Intensities<br> Copula-Based Correlation Modeling<br> Empirical Methods<br> Default-Time Simulation Algorithms<br> Joint Default Events</p> <p class="contents_expanded"><b>11 Collateralized Debt Obligations<br> </b>Some Economics of CDOs<br> Default-Risk Model<br> Pricing Examples<br> Default Loss Analytics<br> Computation of Diversity Scores</p> <p class="contents_expanded"><b>12 Over-the-Counter Default Risk and Valuation<br> </b>Exposure<br> OTC Credit Risk Value Adjustments<br> Additional Swap Credit Adjustments<br> Credit Spreads on Currency Swaps</p> <p class="contents_expanded"><b>13 Integrated Market and Credit Risk Measurement<br> </b>Market Risk Factors<br> Delta-Gamma for Derivatives with Jumps<br> Integration of Market and Credit Risk<br> Examples of VaR with Credit Risk</p> <p class="contents_expanded"><b>Appendix A</b> <br> Introduction to Affine Processes</p> <p class="contents_expanded"><b>Appendix B <br> </b>Econometrics of Affine Term-Structure Models</p> <p class="contents_expanded"><b>Appendix C <br> </b>HJM Spread Curve Models</td> </tr> </table> </td> </tr> </table> <p class="body">While Schönbucher focuses primarily on mathematics, Duffie and Singleton offer a nice blend of theoretical and empirical results. They also offer more examples. These qualities will appeal to practitioners. Finally, Duffie and Singleton are generous in citing useful references. </p> <p class="body">If you are going to read just one book on credit derivatives pricing, that must be Schönbucher, but Duffie and Singleton is an excellent complement. Honestly, anyone who is seriously interested in credit derivatives pricing will read Schönbucher's (<a href="../titles/schonbucher_p_(2003).htm">2003</a>), Bluhm <i>et al</i> (<a href="../titles/bluhm_overbeck_wagner_(2003).htm">2002</a>), <i>and</i> Duffie and Singleton.</p> <p class="body">Also, I recommend Duffie and Singleton for anyone interested in the pricing of convertible debt or in OTC derivatives' potential credit exposure. Useful discussions of these topics are rare. Duffie and Singleton have much to say about each.</p> <p align="center" class="body"> </p> </td> </tr> <tr> <td width="45%" valign="bottom"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table10"> <tr> <td width="100%"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td></tr> </table> </td> </tr> </table> <div align="left"> <table border="0" cellpadding="10" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table11"> <tr> <td width="50%" bgcolor="#FFFFCC" align="center" valign="top"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" bgcolor="#FFFFCC" id="table12"> <tr> <td> <p class="body" style="margin-bottom: 6"><b><font color="#333366" size="3">For related books, see sections:</font></b></p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10"><a target="_top" href="../link_topic/risk_management_credit_institutional.htm">Risk Management - Credit Risk</a></p> <p class="bullet_line_space"><img border="0" src="../images/bullet.gif" width="20" height="10"><a target="_top" href="../link_topic/financial_engineering_credit_risk.htm">Financial Engineering - Pricing Credit Risk</a><p class="bullet_line_space"> <img border="0" src="../images/bullet.gif" width="20" height="10"><a target="_top" href="../link_topic/math_financial_math.htm">Mathematics - Financial Math</a></td> </tr> </table> </td> </tr> </table> </div> </td> <td>  </td> </tr> </table> </div>  <table border="0" style="border-collapse: collapse" width="100%" cellpadding="0" id="table1" bgcolor="#FFFFFF"> <tr> <td colspan="2" height="12"> <p style="margin-top: 0"> </td> </tr> <tr> <td align="right"> <p align="left" style="margin-bottom: 2px"> <a target="_top" href="http://www.riskexpertise.com/link/advertising.htm"> <font size="1" color="#000000" face="Arial">Ads by Contingency Analysis.</font></a></td> <td align="left"> <p align="right" style="margin-bottom: 2px"> <a target="_top" href="http://www.riskexpertise.com/link/advertising.htm"> <font size="1" color="#000000" face="Arial">Advertise on this site.</font></a></td> </tr> <tr> <td align="center" colspan="2">  <iframe src="http://servedbyadbutler.com/adserve/;ID=147917;size=300x250;setID=93136;type=iframe" allowtransparency="true" background-color="transparent" style="margin: 0px; padding: 0px; border-width: 0px" width="300" height="250" frameborder="0" marginwidth="0" marginheight="0" scrolling="no"> <![if lt IE 4]> <script src="http://servedbyadbutler.com/adserve/;ID=147917;size=300x250;setID=93136;type=js" type="text/javascript"> </script> <noscript> <a href="http://servedbyadbutler.com/go2/;ID=147917;size=300x250;setID=93136"> <img src="http://servedbyadbutler.com/adserve/;ID=147917;size=300x250;setID=93136;type=img" border="0" height="250" width="300" alt=""></a> </noscript><![endif]> </iframe>   </td> </tr> </table> <p align="center" style="margin-top: 20"> <map name="FPMap0_I1"> <area href="http://www.riskbook.com" shape="rect" coords="0, 0, 184, 29" target="_top"></map> <img border="0" src="../images/open_book_riskbook.gif" usemap="#FPMap0_I1" width="185" height="30"></p> <p class="a" align="center"><font face="Arial" size="2"><a href="../main/disclaimer.htm">disclaimer</a></font></p> <p class="a" align="center"><span class="verdana10">website:</span> <a target="_top" href="http://www.contingencyanalysis.com"> <font size="2" face="Arial">http://www.contingencyanalysis.com</font></a><br> <span class="verdana10">books direct link:</span> <a target="_top" href="http://www.riskbook.com"><font size="2" face="Arial">http://www.riskbook.com</font></a><br> copyright <font face="Times New Roman">©</font> Contingency Analysis, 1996 - current</p> <p class="a" align="center"><map name="FPMap1_I1"> <area target="_top" href="http://www.contingencyanalysis.com" shape="rect" coords="0, 0, 240, 88"> </map><img border="0" src="../images/logo_book_white.gif" usemap="#FPMap1_I1" width="241" height="89"></p>  </body>