Results from portfolio models for credit risk tell us that loan concentration in certain industry sectors can substantially increase the value-at-risk (V aR). The purpose of this paper is to analyse if a very tractable “infection model” can provide a meaningful estimate of the impact of concentration risk on the V aR. This would be achieved with quite parsimonious data requirements, which are c...

Using the industrial economics approach to the microeconomics of banking we analyze a large bank under credit risk. Our aim is to study how a risky loan portfolio affects optimal bank behavior in the loan and deposit markets, when credit derivatives to hedge credit risk are available. We examine hedging without and with basis risk. In the absence of basis risk the usual separation result is con...

Observation of historical default rates supports the idea that default events (and, more generally, all indicators of credit quality and transition) are correlated. Default correlations are caused by similar economic conditions and, within a sector, by industry-specific reasons. However, incorporating default correlation in any portfolio credit risk analysis is difficult because of the lack of ...

Credit risk transition probabilities between aggregate portfolio classes constitute a very useful tool when individual transition data are not available. Jones (2005) estimates Markovian Credit Transition Matrices using an adjusted least squares method. Given the arguments of Judge and Takayama (1966) a least squares estimator under inequality constraints is consistent but has unknown distribut...

As an integrated part of a supply contract, trade credit has intrinsic connections with supply chain contracting and inventory management. Using a stylized model that explicitly captures the interaction of firms’ operations decisions and financial risks, this paper attempts to develop a deeper understanding of trade credit from an operational perspective. Revolving around the question of what r...

The paper presents a simulation framework for measuring and managing the default risk of a loan portfolio. Through the dependency of counterparty default on a systematic risk factor, we explore the economic capital requirement for a hypothetical credit portfolio. The study employs bivariate standard normal distribution for mapping asset return correlations into default correlations. Monte Carlo...

The measurement of portfolio credit risk focuses on rare but significant large-loss events. This paper investigates rare event asymptotics for the loss distribution in the widely used Gaussian copula model of portfolio credit risk. We establish logarithmic limits for the tail of the loss distribution in two limiting regimes. The first limit examines the tail of the loss distribution at increasi...

We study the impact of contagion in a network of firms facing credit risk. We describe an intensity based model where the homogeneity assumption is broken by introducing a random environment that makes it possible to take into account the idiosyncratic characteristics of the firms. We shall see that our model goes behind the identification of groups of firms that can be considered basically exc...

This paper introduces a new importance sampling technique to increase the efficiency of rare event simulation. By using a multidimensional rotational invariant auxiliary density, this method can be applied to estimate risk measures for credit risk portfolios where the method of importance sampling via mean shifting is not suitable. The loss distribution of the portfolio is obtained by simulatin...

The Internal Ratings Based (IRB) approach suggested in the New Basel Accord regulations (BIS 2005) uses a capital allocation formula derived from a Merton style structural model of the credit risk of portfolios of corporate loans. Yet this formula is being applied in the case of consumer loans as well as corporate loans. This has highlighted that although there are a number of well established ...