NORTA for portfolio credit risk

Mohamed A. Ayadi, Hatem Ben-Ameur, Nabil Channouf, Quang Khoi Tran

Research output: Contribution to journalArticle

Abstract

We use NORTA (NORmal To Anything) to enhance normal credit-risk factor settings in modeling common risk factors and capturing contagion effects. NORTA extends the multivariate Normal distribution in that it enables the simulation of a random vector with arbitrary and known marginals and correlation structure. NORTA can be solved either by numerical integration (Cario and Nelson in Modeling and generating random vectors with arbitrary marginal distributions and correlation matrix, Technical report, Department of Industrial Engineering and Management Sciences, Northwestern University, IL, 1997) or by Monte Carlo simulation (Ilich in Eur J Oper Res 192(2):468–478, 2009). The former approach, which is the most efficient, assumes that the marginals’ inverse cumulative functions are given, while the latter, which is more flexible but less efficient, does not. We show how to combine both approaches for higher flexibility and efficiency. We solve for NORTA and experiment with Normal, Student, and Asymmetric Exponential Power (AEP) distributions. We match NORTA models to Normal models with the same marginals’ first and second moments. Yet, differences in credit-risk measures can be highly significant. This supports NORTA as a viable alternative for credit-risk modeling and analysis.

Original languageEnglish
Pages (from-to)1-21
Number of pages21
JournalAnnals of Operations Research
DOIs
Publication statusAccepted/In press - Apr 2 2018

Fingerprint

Credit risk
Portfolio credit risk
Risk factors
Modeling
Correlation matrix
Monte Carlo simulation
Risk measures
Power distribution
Numerical integration
Simulation
Credit risk modeling
Experiment
Contagion effect
Management science
Multivariate normal distribution
Industrial engineering
Correlation structure

Keywords

  • Factor models
  • Finance
  • Monte Carlo simulation
  • NORTA
  • Numerical integration
  • Portfolio credit risk

ASJC Scopus subject areas

  • Decision Sciences(all)
  • Management Science and Operations Research

Cite this

NORTA for portfolio credit risk. / Ayadi, Mohamed A.; Ben-Ameur, Hatem; Channouf, Nabil; Tran, Quang Khoi.

In: Annals of Operations Research, 02.04.2018, p. 1-21.

Research output: Contribution to journalArticle

Ayadi, Mohamed A. ; Ben-Ameur, Hatem ; Channouf, Nabil ; Tran, Quang Khoi. / NORTA for portfolio credit risk. In: Annals of Operations Research. 2018 ; pp. 1-21.
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