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Estimating Asset Correlations from Stock Prices or Default Rates - Which Method is Superior?
Company: Deutsche Bundesbank
Year Of Publication: 2008
Month Of Publication: April
Pages: 48
Download Count: 14
View Count: 1721
Comment Num: 0
Language: English
Source: working paper
Who Can Read: Free
Date: 8-16-2010
Publisher: Administrator
Summary
This paper sets out to help explain why estimates of asset correlations based on equity prices tend to be considerably higher than estimates based on default rates. By means of a simulation study, we explore the hypothesis that differences in the correlation estimates are due to a substantial downward bias characteristic
of estimates based on default rates. Our results suggest that correlation estimates from equity returns are more efficient than those from default rates. This finding still holds if the model is misspecified such that asset correlations follow a Vasicek process which affects foremost the estimates from equity returns. The results lend support for the hypothesis that the downward bias of default-rate based estimates is an important although not the only factor to explain the differences in correlation estimates. Furthermore, our
results help to quantify the estimation error of asset correlations dependent on the risk characteristics of the underlying data base.
Author(s)
Duellmann, Klaus Sign in to follow this author
Kunisch, Michael Sign in to follow this author
Küll, Jonathan Sign in to follow this author
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