Credit risk management in banks using copula

Abstract

This report explores the modern methods used in Credit Risk Management in Banks. It describes the model built to value a portfolio of loans and thus calculate the credit risk VAR of the portfolio using copulas to model the dependencies between the loans in the portfolio. The report addresses the two challenges faced in doing the same – ?? Pricing of loan products issued by banks which have prepayment options and a probability of default ?? Pricing of a portfolio of loans with default correlation using copulas Towards the end, a sensitivity analysis of VARs obtained using the Student (df=10) and Gaussian copulas is done for changes in values of hazard rate of the loans, correlation matrix of the loan portfolio and recovery value of the loans that might deviate from the current value with the arrival of new information.