Copula-Based Portfolio Credit Risk Assessment in Infrastructure Project Financing

Abstract

Project lenders are concerned about credit risk management in infrastructure project financing. According to the maxim in risk management, “you cannot manage what you cannot measure,” so project lenders want to know the exposure of their debt loss. Although many sophisticated credit risk models have been developed for corporate financing, only some relevant literature has focused on credit risk assessment for infrastructure projects. However, the models developed assume that project debt lenders invest only in one single project at a time. In fact, project lenders are inclined to be simultaneously involved in a portfolio of assets around the world rather than a single local project asset in order to diversify away idiosyncratic risks of an individual infrastructure project. Consequently, in order to meet project lenders’ needs, this article presents a copula-based model to measure the credit risk of a portfolio of projects by implementing the variance model and the double stochastic intensity model. A numerical example of two interdependent projects is shown as a case study to illustrate how to quantify this joint default risk in infrastructure project financing. <b>TOPICS:</b>Private equity, project finance, credit risk management, statistical methods