I am trying to understand the difference and similarities between Credit Spread Risk and Credit Default Risk.
Here is brief (and not all too precise) definition.
- Credit Spread Risk: Losses due to changes in credit spreads - measured using a Value-at-Risk (VaR) approach.
- Credit Default Risk: Losses due to changes in PD and LGD - measured using an Unexpected Loss (UL) approach.
For simplicity sake, lets consider a portfolio which consists of a single zero-coupon bond.
Credit Spread Risk deals with changes in credit spreads. One of the main reasons why the Credit Spread of our bond might change is that market participants believe that the available information on potential future losses has changed. But this risk is also included in the definition of credit default risk.
I was wondering if to a certain degree these two risk definitions overlap and whether there are methods to quantify this overlap. So for example assume that for this particular bond we have that
- Credit-Spread-VaR = 200
- Credit Default UL = 100
Do you know any methods on how to quantify the overlap? Or put differently, do you know any methods to analyse if these figures include any kind of double counting of risks?
The way I see it (as of now) Credit Default Risk should to a large extend be included in Credit Spread Risk.