Measuring Default Correlation

Observation of historical default rates supports the idea that default events (and, more generally, all indicators of credit quality and transition) are correlated. Default correlations are caused by similar economic conditions and, within a sector, by industry-specific reasons. However, incorporating default correlation in any portfolio credit risk analysis is difficult because of the lack of good data on default correlation, and the complexity of developing realistic models of default correlations that capture its dependence on credit quality, region, industry and time horizon.