Portfolio Models of Credit Loss by Edu Pristine

Author of lecture Portfolio Models of Credit Loss

Edu Pristine

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... approaches to Credit Risk Modelling -Explain Credit VaR -Define Credit Migration - Describe the Credit Metrics Framework -Demonstrate Credit VaR for a single Bond/Loan -Demonstrate the Estimation of Default and Rating Changes Correlations ...

... to pre-specified priority rules. -Default, is usually defined as the event that a firm misses a payment on a coupon and/or the reimbursement of principal at debt maturity. –Cross-default clauses on debt ...

... 4 Credit Risk at Portfolio Level. -Credit standing of Individual Obligors ...

... much capital is required to cover worst-case loss. -Risk contribution of each exposure may also be determined and this can impact the pricing decision (E.g. bank may decide to price an exposure lower than its credit spread, if it is providing diversification benefit). -Portfolio models consist of: –Default only models: Based on Moodys’ KMV Portfolio ...

... a similar fashion to market risk, except that the risk horizon is usually much longer. It is simply the distance from the mean to the percentile of the forward distribution, at the desired confidence level. However, the future point in time is typically one year for both regulatory and economic credit risk capital, whereas for market VaR the risk horizon is 10 days for regulatory capital (but again, usually one year) ...

... with them substantial ‘downsides’. Unlike market VaR, the percentile levels of the distribution cannot be estimated from the mean and variance only. The calculation of VaR for credit risk thus demands a simulation of the full distribution of the changes in the value of the portfolio. -The Credit Metrics risk measurement framework consists of two main building blocks: –VaR due to credit for a single financial instrument; and –VaR at the portfolio level, which accounts for portfolio diversification effects. -The first step is to specify a rating system, with rating categories ...

... -Default correlations are taken from correlation between stock price returns. LGD is incorporated through a parameterized distribution (like Beta distribution). -Like KMV Model, this model also assumes that changes in asset values of a firm follow a normal distribution ...