A copula-based systemic risk measure: application to investment-grade and high-yield CDS portfolios

Abstract

This study investigates the evolution of systemic risk inherent in investment-grade (IG) and high-yield (HY) CDS portfolios and compares the portfolios before and after the global financial crisis. To quantify systemic risk, we propose a novel measure – the expected default rate (EDR), defined by the average default rate of all institutions conditional upon one institution being in default. We implement the EDR under the one-factor copula framework with various dependence structures. We observe that the HY portfolio contains a higher systemic risk than the IG’s, overall, and the gap between the two widens after Lehman Brothers’ default. However, the model discrepancy for IG EDR is higher than that for HY, and for both the IG and HY EDRs, the discrepancies decrease over time.