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The Influence of Mortgage Portfolio on the Term Structure of Credit Spreads

Author: HuJiZhen
Tutor: WangXueBiao
School: Dongbei University of Finance
Course: Quantitative Economics
Keywords: mortgage credit risk term structure of credit spreads
CLC: F831
Type: Master's thesis
Year: 2010
Downloads: 28
Quote: 0
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Abstract

As the rapid development of economic globalization and Chinese economy, China’s financial industry gradually opening up and closely connects with the world’s financial industry. China’s banking is more and more involved in the world financial transactions, but this also makes risk to China’s financial industry, especially in credit risk. One of the biggest problems which the world financial industry pays attention to is the credit risk management, and the research about this has been perfected continually. Many nations are trying to establish a good credit risk model to prevent credit risk and reduce risk loss.Basel Concordat gives a credit risk management standard to global banking, at the same time many financial institutions have established their own credit risk model for risk management.Credit risk model mainly research the term structure of credit spreads and based on this we can discuss the pricing of the derivatives, the rapid development of the credit derivatives bring the structure change of financial market and the reform of credit risk management. The credit derivatives can transfer the credit risk and can remove or eliminate the exposure of risk dimension without changing the ownership of the foundation assets.In the financial crisis at 1997, credit derivatives can made banks to get some debt recovery under currency crisis and can protect financial industry. But in the global financial crisis at 2008 which made by subprime loans, the credit derivatives did not take protective effect. The main reason of this financial crisis is that make credit risk as the foundation assets, people use derivatives to transfer credit but this does not diversify risks, this can increases the liquidity of risk,this makes the risk extend very quickly once the crisis happen. So the research focus is how to perfect credit derivatives to diversify risks and how to establish perfect financial risks system.Spread is a important tool to product credit derivatives, so it is very important to research the term structure of credit spreads and base on this we can price the derivatives.Basel Concordat shows that mortgage is a major method for alleviating credit risk, because it reduces the risk exposure. So it is very important for credit risk pricing and mortgage management to analyze the credit risk value with risk mortgage. The collateral may not only single assets, but also can be portfolio of assets. The portfolio can impact on the mortgage risk. Therefore it is more meaningful to research the portfolio of collaterals. Nowadays most of the research of credit risk pricing is about the single collateral, only few people’s research is about the portfolio of collaterals, most researchers study the term structure of credit spreads by empirical analysis but the theoretical research is seldom. The studies in this paper have great significance to enrich our theory about credit risk and to improve our financial risks system.If we want to study the term structure of credit spreads, you must research the credit risk pricing model first. There are three kinds of credit risk model:structure model, reduced model and mixed model. If the collateral is asset, currently in China seldom people study the credit risk model when the collateral portfolio exists. In this paper I selects three models, Merton model, Birys and de Varenne model, Jarrow,Lando and Turnbull model, and extend these models when the portfolio of collaterals exist, then get the formula of the term structure of credit spreads from the three extended model. In this paper I use Monte Carlo simulation method to simulate the term structure of credit spreads, the results of this simulation indicate that when there is collateral portfolio, the credit spreads of the zero-coupon bond is smaller than that without collateral and the default probability is also less then that without collateral, all of these show that the mortgage can surly alleviate the credit risk. But the credit spreads with collateral portfolio may larger or smaller than that with single collateral, so this need us select suitable portfolio to reduce the credit risk. When there is no collateral, the previous results show that the term structure of credit spreads is hump-shaped, but the in this paper I get another shape when I use the extended Merton model and get the similar shape when I use the extended Birys and de Varenne model.When we don’t consider about mortgage, the credit derivatives pricing which get according to the term structure of credit spreads is not accurate, there are arbitrage opportunities which make disadvantage to the stability of derivatives market. If we use the term structure of credit spreads when the collateral portfolio exist, we can make the price of credit derivatives more exactly, which makes the financial market more stable and decrease the opportunity of happening large scale financial crisis.Therefore, the study in this paper has important theoretical and practical significance.

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