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One More Model Risk when Using Gaussian Copula for Risk Management
Company: Bocconi University
Year Of Publication: 2009
Month Of Publication: April
Pages: 8
Download Count: 10
View Count: 1153
Comment Num: 0
Language: English
Source: working paper
Who Can Read: Free
Date: 7-6-2010
Publisher: Administrator
Summary
Gaussian Copula as a model for default correlation has been recently criticized for
a number of fallacies in its application to pricing and risk management of ¯nancial
liabilities. Here we point out an element of model risk that appears to be overlooked.
When the Gaussian Copula is applied to the computation of the probability of losses
concentrated in time, it can give paradoxical and misleading results, where an increase
of correlation reduces the model probability of loss concentration. This behaviour
is dangerous since, if not taken into account, can lead to completely wrong model
stress testing. Here we show how this behaviour can a?ect three practical problems:
the estimation of future liquidity risk due to clustered losses, the assessment of CDS
counterparty risk and the computation of dynamic value-at-risk
Author(s)
Morini, Massimo Sign in to follow this author
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