Marshall-Olkin distributions, subordinators, efficient simulation, and applications to credit risk

Yunpeng Sun, Rafael Mendoza-Arriaga, Vadim Linetsky

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

In the paper we present a novel construction of Marshall-Olkin (MO) multivariate exponential distributions of failure times as distributions of the first-passage times of the coordinates of multidimensional Lévy subordinator processes above independent unit-mean exponential random variables. A time-inhomogeneous version is also given that replaces Lévy subordinators with additive subordinators. An attractive feature of MO distributions for applications, such as to portfolio credit risk, is its singular component that yields positive probabilities of simultaneous defaults of multiple obligors, capturing the default clustering phenomenon. The drawback of the original MO fatal shock construction of MO distributions is that it requires one to simulate 2n-1 independent exponential random variables. In practice, the dimensionality is typically on the order of hundreds or thousands of obligors in a large credit portfolio, rendering the MO fatal shock construction infeasible to simulate. The subordinator construction reduces the problem of simulating a rich subclass of MO distributions to simulating an n-dimensional subordinator. When one works with the class of subordinators constructed from independent one-dimensional subordinators with known transition distributions, such as gamma and inverse Gaussian, or their Sato versions in the additive case, the simulation effort is linear in n. To illustrate, we present a simulation of 100,000 samples of a credit portfolio with 1,000 obligors that takes less than 18 seconds on a PC.

Original languageEnglish (US)
Pages (from-to)481-514
Number of pages34
JournalAdvances in Applied Probability
Volume49
Issue number2
DOIs
StatePublished - Jun 1 2017

Keywords

  • Lévy process
  • Marshall-Olkin multivariate exponential distribution
  • additive subordinator
  • credit risk
  • default
  • dependent lifetime
  • failure
  • reliability
  • simulation
  • subordinator

ASJC Scopus subject areas

  • Statistics and Probability
  • Applied Mathematics

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