The independent sector assumption in the CreditRiskC model has been a major
obstacle to its implementation. Attempts to overcome this limitation have not met
with much success. This paper proposes an extension of the original model that
accommodates a wide range of sector covariance structures. Existing numerical
algorithms designed for the original model can be reused with little modification.
Case studies demonstrate that our model outperforms other CreditRiskC
variants that allow sector dependency. A simulation version of our model is also
introduced, which is in turn used to find an optimal portfolio allocation based
on the work of Andersson et al. The simulation error is very small compared
with the model’s analytic counterpart, and the optimization significantly reduces
portfolio credit risk.