Measuring and managing market, credit and Op risk [50]

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Bullet points include: Often create model with latent variables, e.g. via ordered probit techniques Common assumption: correlations between latent variables specified in this manner equal correlations between the obligors’ equity returns (if available) In principle, alternatives include bond spread change correlations or default data correlations, but equity returns simplest to access C.f. Merton model for firm In practice, instead of actual obligor specific equity returns, it is common to use returns on weighted average of industry and country equity indices plus idiosyncratic noise

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