A Simplified Method for Calculating the Credit Risk of Lending Portfolios
AbstractThe common practice for managing the credit risk of lending portfolios is to the calculate the maximum loss within the "value at risk" framework. Most financial institutions use large-scale Monte Carlo simulations to do this. However, such simulations may impose heavy calculation loads. This paper proposes a simplified method that approximates maximum loss with minimal simulation burden. Our method divides a portfolio into subportfolios at each credit rating level and calculates the maximum loss of each subportfolio. We assume that the subportfolio's structure provokes little fluctuation in the ratio between the maximum loss and the standard deviation. We therefore begin with a subportfolio in which each exposure is of the same amount (a homogeneous subportfolio). Simple calculations provide the standard deviation for both the heterogeneous subportfolio whose risk is to be measured and the homogeneous subportfolio. The maximum loss for the homogeneous subportfolio can be obtained by using analytical techniques rather than simulations. The maximum loss for a heterogeneous subportfolio is then approximated by multiplying the ratio of the maximum loss and standard deviation of the homogeneous subportfolio by the standard deviation of the heterogeneous subportfolio. Simulation examples indicate that this approximation is effective in all portfolios except those including extremely large exposures. This paper also describes a technique for using the total maximum loss of all subportfolios to find the maximum loss for the entire portfolio.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.
Volume (Year): 18 (2000)
Issue (Month): 2 (December)
Contact details of provider:
Postal: 2-1-1 Nihonbashi, Hongoku-cho, Chuo-ku, Tokyo 103
Web page: http://www.imes.boj.or.jp/
More information through EDIRC
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kinken).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.