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Question 21.1: Explain the difference between Vasicek’s model, the Credit R...

Explain the difference between Vasicek’s model, the Credit Risk Plus model, and CreditMetrics as far as the following are concerned: (a) when a credit loss is recognized and (b) the way in which default correlation is modeled.

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In Vasicek’s model and Credit Risk Plus, a credit loss is recognized when a default occurs. In CreditMetrics, both downgrades and defaults lead to credit losses. In Vasicek’s model, a Gaussian copula model of time to default is used. In Credit Risk Plus, a probability distribution is assumed for the default rate per year. In CreditMetrics, a Gaussian copula model is used to define rating transitions.

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