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| Default Correlation and Its Effect on Portfolios of Credit Risk by Richard V. Hrvatin of Fitch Ratings, and February 17, 2004 Summary: The stressful credit environment experienced over the past few years has raised many intriguing questions about the benefits of diversification and its effect on default risk. Portfolios that were thought to be diverse, and thus shielded from the risk of multiple credit events, actually experienced more downgrades and defaults than anticipated and did not necessarily perform better than less diversified portfolios. Structured transactions, such as collateralized debt obligations (CDOs), are subject to maximum allowable exposures to any one issuer or industry, but typically there is no distinction made among industries. Thus, two portfolios that appear to be equally diverse in accordance with the same set of investment guidelines may actually experience vastly different credit performance. This has prompted Fitch Ratings to look further into the issue of portfolio diversification and study how correlation between issuers and industries affects portfolio credit performance. Download paper (345K PDF) 11 pages Related reading: A Comparative Empirical Study of Asset Correlations
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