Default correlation

The tendency for borrowers to default together, usually because of shared economic factors. Higher correlation fattens the tail of portfolio losses.

Where you will meet it

Default correlation comes up in 20 learning outcome notes across the FRM syllabus. A few of them:

• Anatomy of the Great Financial Crisis of 2007-2009
  FRM Part I · Foundations of risk management

  “They used models with low default correlation and short house price histories, and they faced rating shopping by arrangers.”

• Measuring Returns, Volatility, and Correlation
  FRM Part I · Quantitative analysis

  “It underlies Gaussian copula models of default correlation.”

• Measuring Credit Risk
  FRM Part I · Valuation and risk models

  “With pairwise default correlation ρ, Variance = p(1 − p) × [1 ÷ n + (n − 1) ÷ n × ρ].”

• Credit Risk Management
  FRM Part II · Credit risk measurement and management

  “UL is covered by capital, and for a portfolio it depends on default correlation.”

See also

Correlation

All terms beginning with D · FRM glossary

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