Review of Finance Vol. 18 No. 5 2014
Default Correlations in the Merton Model
open access
Abstract
We examine the relationship between default probabilities and default correlations of two firms in the Merton model. We show that default correlations increase under a homogeneous increase of default probabilities. The same is true if the increase of the default probability is more pronounced for the firm with the lower likelihood of default. Default correlations may only decline if the increase of the default probability is significantly larger for the firm with higher default risk. These findings may have important implications for the assessment of credit portfolio risk, loan pricing, and capital requirements when adverse macroeconomic shocks occur.
- DOI
- 10.1093/rof/rft030
- Volume
- 18
- Issue
- 5
- Pages
- 1775-1809
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref