A transient Cram\'er-Lundberg model with applications to credit risk

Abstract

This paper considers a variant of the classical Cram\'er-Lundberg model that is particularly appropriate in the credit context, with the distinguishing feature that it corresponds to a finite number of obligors. The focus is on computing the ruin probability, i.e., the probability that the initial reserve, increased by the interest received from the obligors and decreased by the losses due to defaults, drops below zero. Besides an exact analysis (in terms of transforms) of this ruin probability, also an asymptotic analysis is performed, including an efficient importance-sampling based simulation approach. The base model is extended in multiple dimensions: (i) we consider a model in which there may, in addition, be losses that do not correspond to defaults, (ii) then we analyze a model in which the individual obligors are coupled through a regime-switching mechanism, (iii) then we extend the model such that between the losses the reserve process behaves as a Brownian motion rather than a deterministic drift, and (iv) we finally consider a set-up with multiple groups of statistically identical obligors.