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A New Framework for Measuring the Credit Risk of a Portfolio: The "ExVaR" Model

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  • Oda, Nobuyuki

    (Bank of Japan)

  • Muranaga, Jun

    (Bank of Japan)

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    Abstract

    This paper proposes a new framework for the quantitative evaluation of the credit risk of a portfolio by extending the concept of value at risk. In practice, the risk evaluation period is set individually for each transaction in the portfolio and a simulation is carried out on the movements of default probabilities, interest rates, and collateral asset prices as well as on the realization of defaults of counter parties. The result fixes the cash flow along the simulated path and leads to the present value of the total cash flows. By repeating this procedure many times, we obtain the probability distribution of the present value, by which we can evaluate the price and the risk of the portfolio. This framework enables us comprehensively and objectively to measure the risk taking into account the diversification/concentration effect, the collateral effect, and the correlation between credit risk factors and market risk factors. After presenting the methodology, the paper calculates the risk of hypothetical test portfolios. They are used to discuss the applicability of the framework to practical uses.

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    File URL: http://www.imes.boj.or.jp/research/papers/english/me15-2-2.pdf
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    Bibliographic Info

    Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

    Volume (Year): 15 (1997)
    Issue (Month): 2 (December)
    Pages: 27-62

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    Handle: RePEc:ime:imemes:v:15:y:1997:i:2:p:27-62

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    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    2. Gregory R. Duffee, 1994. "On measuring credit risks of derivative instruments," Finance and Economics Discussion Series 94-27, Board of Governors of the Federal Reserve System (U.S.).
    3. Steven R. Grenadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," NBER Working Papers 5178, National Bureau of Economic Research, Inc.
    4. Boyes, William J. & Hoffman, Dennis L. & Low, Stuart A., 1989. "An econometric analysis of the bank credit scoring problem," Journal of Econometrics, Elsevier, vol. 40(1), pages 3-14, January.
    5. Johnsen, Thomajean & Melicher, Ronald W., 1994. "Predicting corporate bankruptcy and financial distress: Information value added by multinomial logit models," Journal of Economics and Business, Elsevier, vol. 46(4), pages 269-286, October.
    6. Wu, Chunchi & Yu, Chih-Hsien, 1996. "Risk aversion and the yield of corporate debt," Journal of Banking & Finance, Elsevier, vol. 20(2), pages 267-281, March.
    7. Steven R. Renadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," Harvard Institute of Economic Research Working Papers 1718, Harvard - Institute of Economic Research.
    8. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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