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227
A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules
- Journal of Financial Intermediation
, 2003
"... When economic capital is calculated using a portfolio model of credit value-at-risk, the marginal capital requirement for an instrument depends, in general, on the properties of the portfolio in which it is held. By contrast, ratings-based capital rules, including both the current Basel Accord and i ..."
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Cited by 294 (1 self)
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When economic capital is calculated using a portfolio model of credit value-at-risk, the marginal capital requirement for an instrument depends, in general, on the properties of the portfolio in which it is held. By contrast, ratings-based capital rules, including both the current Basel Accord and its proposed revision, assign a capital charge to an instrument based only on its own characteristics. I demonstrate that ratingsbased capital rules can be reconciled with the general class of credit VaR models. Contributions to VaR are portfolio-invariant only if (a) there is only a single systematic risk factor driving correlations across obligors, and (b) no exposure in a portfolio accounts for more than an arbitrarily small share of total exposure. Analysis of rates of convergence to asymptotic VaR leads to a simple and accurate portfolio-level add-on charge for undiversified idiosyncratic risk. There is no similarly simple way to address violation of the single factor assumption.
The Link between Default and Recovery Rates: Effects on the Procyclicality of Regulatory Capital Ratios, BIS Working Papers, No 113.
, 2002
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Procyclicality of the financial system and financial stability: issues and policy options
- BIS PAPERS
, 2001
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Ratings migration and the business cycle, with application to credit portfolio stress testing
- Journal of Banking and Finance
, 2002
"... Abstract: The turmoil in the capital markets in 1997 and 1998 has highlighted the need for systematic stress testing of banks ’ portfolios, including both their trading and lending books. We propose that underlying macroeconomic volatility is a key part of a useful conceptual framework for stress te ..."
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Cited by 123 (3 self)
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Abstract: The turmoil in the capital markets in 1997 and 1998 has highlighted the need for systematic stress testing of banks ’ portfolios, including both their trading and lending books. We propose that underlying macroeconomic volatility is a key part of a useful conceptual framework for stress testing credit portfolios, and that credit migration matrices provide the specific linkages between underlying macroeconomic conditions and asset quality. Credit migration matrices, which characterize the expected changes in credit quality of obligors, are cardinal inputs to many applications, including portfolio risk assessment, modeling the term structure of credit risk premia, and pricing of credit derivatives. They are also an integral part of many of the credit portfolio models used by financial institutions. By separating the economy into two states or regimes, expansion and contraction, and conditioning the migration matrix on these states, we show that the loss distribution of credit portfolios can differ greatly, as can the concomitant level of economic capital to be assigned to a bank.
The Economic Effects of Technological Progress: Evidence from the Banking Industry
- Journal of Money, Credit and Banking
, 2003
"... This paper examines technological progress and its effects in the banking industry. Banks are intensive users of both IT and financial technologies, and have a wealth of data available that may be helpful for the general understanding of the effects of technological change. The research suggests imp ..."
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Cited by 91 (4 self)
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This paper examines technological progress and its effects in the banking industry. Banks are intensive users of both IT and financial technologies, and have a wealth of data available that may be helpful for the general understanding of the effects of technological change. The research suggests improvements in costs and lending capacity due to improvements in “back-office ” technologies, as well as consumer benefits from improved “front-office ” technologies. The research also suggests significant overall productivity increases in terms of improved quality and variety of banking services. In addition, the research indicates that technological progress likely helped facilitate consolidation of the industry.
Good and Bad Credit Contagion: Evidence from Credit Default Swaps,”
- Journal of Financial Economics,
, 2007
"... Abstract This study examines the information transfer effect of credit events across the industry, as captured in the Credit Default Swaps (CDS) and stock markets. Positive correlations across CDS spreads imply dominant contagion effects, whereas negative correlations indicate competition effects. ..."
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Cited by 84 (6 self)
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Abstract This study examines the information transfer effect of credit events across the industry, as captured in the Credit Default Swaps (CDS) and stock markets. Positive correlations across CDS spreads imply dominant contagion effects, whereas negative correlations indicate competition effects. We find strong evidence of dominant contagion effects for Chapter 11 bankruptcies and competition effect for Chapter 7 bankruptcies. We also introduce a purely unanticipated event, which is a large jump in a company's CDS spread, and find that this leads to the strongest evidence of credit contagion across the industry. These results have important implications for the construction of portfolios with credit-sensitive instruments. JEL Classifications: G14 (Market Efficiency), G18 (Policy and Regulation), G33 (Bankruptcy)
2006), “Procyclicality in Basel II: Can We Treat the Disease Without Killing the Patient
- Journal of Financial Intermediation
"... The views expressed herein are our own and do not necessarily reflect those of the Board of Governors or its staff. We thank Allen Berger, Mark Carey, Erik Heitfield and Tom Wilde for helpful comments. Email: ..."
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Cited by 79 (0 self)
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The views expressed herein are our own and do not necessarily reflect those of the Board of Governors or its staff. We thank Allen Berger, Mark Carey, Erik Heitfield and Tom Wilde for helpful comments. Email:
Macroeconomic dynamics and credit risk: A global perspective
- Journal of Money Credit and Banking
, 2006
"... We develop a framework for modeling conditional loss distributions through the introduction of risk factor dynamics. Asset value changes of a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro effects to be isolated from idiosyncratic shocks from the perspective o ..."
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Cited by 71 (14 self)
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We develop a framework for modeling conditional loss distributions through the introduction of risk factor dynamics. Asset value changes of a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro effects to be isolated from idiosyncratic shocks from the perspective of default (and hence loss). Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. The model is able to control for firm-specific heterogeneity as well as generate multi-period forecasts of the entire loss distribution, conditional on specific macroeconomic scenarios. The approach can be used, for example, to compute the effects of a hypothetical negative equity price shock in South East Asia on the loss distribution of a credit portfolio with global exposures over one or more quarters. The approach has several other features of particular relevance for risk managers, such as the exploration of scale and symmetry of shocks, and the effect of non-normality on credit risk. We show that the effects of such shocks on losses are asymmetric and non-proportional, reflecting the highly non-linear nature of the credit risk model. Non-normal innovations such as Student t generate expected and unexpected losses which increase the fatter the tails of the innovations.
The empirical relationship between average asset correlation, firm probability of default and asset size
- Journal of Financial Intermediation
, 2004
"... ABSTRACT: The asymptotic single risk factor (ASRF) approach is a simplified framework for determining regulatory capital charges for credit risk and has become an integral part of how credit risk capital requirements are to be determined under the second Basel Accord. Within this approach, a key reg ..."
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Cited by 69 (2 self)
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ABSTRACT: The asymptotic single risk factor (ASRF) approach is a simplified framework for determining regulatory capital charges for credit risk and has become an integral part of how credit risk capital requirements are to be determined under the second Basel Accord. Within this approach, a key regulatory parameter is the average asset correlation. In this paper, we examine the empirical relationship between the average asset correlation, firm probability of default and firm asset size measured by the book value of assets by imposing the ASRF approach within the KMV methodology for determining credit risk capital requirements. Using data from year-end 2000, credit portfolios consisting of U.S., Japanese and European firms are analyzed. The empirical results suggest that average asset correlation is a decreasing function of probability of default and an increasing function of asset size. When compared with the average asset correlations proposed by the Basel Committee on Banking Supervision in November 2001, the empirical average asset correlations further suggest that accounting for firm asset size, especially for larger firms, may be important. In conclusion, the empirical results suggest that a variety of factors may impact average asset correlations within an ASRF framework, and these factors may need to be accounted for in the final calculation of regulatory capital requirements for credit risk.
Parameterizing credit risk models with rating data
- Journal of Banking and Finance
, 2001
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