Default Probability Estimation via Pair Copula Constructions

TL;DR

This paper introduces a new method for estimating firm default probabilities using pair copula constructions and Monte Carlo simulations, based on balance sheet data and contingent claim analysis.

Contribution

It presents a novel approach combining pair copula models with multivariate contingent claims for more accurate default probability estimation.

Findings

Effective estimation of default probabilities demonstrated

Application to real firm data shows practical viability

Method outperforms traditional models in certain scenarios

Abstract

In this paper we present a novel approach for firm default probability estimation. The methodology is based on multivariate contingent claim analysis and pair copula constructions. For each considered firm, balance sheet data are used to assess the asset value, and to compute its default probability. The asset pricing function is expressed via a pair copula construction, and it is approximated via Monte Carlo simulations. The methodology is illustrated through an application to the analysis of both operative and defaulted firms.