Interaction of market and credit risk:an analysis of inter-risk correlationand risk aggregation

In this paper we investigate the interaction between a credit portfolio and another risktype, which can be thought of as market risk. Combining Merton-like factor models forcredit risk with linear factor models for market risk, we analytically calculate their interriskcorrelation and show how inter-risk correlation bounds can be derived. Moreover, weelaborate how our model naturally leads to a Gaussian copula approach for describingdependence between both risk types. In particular, we suggest estimators for the correlationparameter of the Gaussian copula that can be used for general credit portfolios.Finally, we use our findings to calculate aggregated risk capital of a sample portfolio bothby numerical and analytical techniques.