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Ratings versus equity-based credit risk modelling: an empirical analysis

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  • Pamela Nickell
  • William Perraudin
  • Simone Varotto

Abstract

Banks have recently developed new techniques for gauging the credit risk associated with portfolios of illiquid, defaultable instruments. These techniques could revolutionise banks' management of credit risk and could in the longer term serve as a more risk-sensitive basis for calculating regulatory capital on banks' loan books than the current 8% capital charge. In this paper, examples are implemented of the two main types of credit risk model developed so far: ratings-based and equity-based approaches. Using price data on large eurobond portfolios, the paper assesses, on an out-of-sample basis, how well these models track the risks they claim to measure.

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File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2001/wp132.pdf
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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 132.

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Date of creation: May 2001
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Handle: RePEc:boe:boeewp:132

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  1. Jose A. Lopez & Marc R. Saidenberg, 1999. "Evaluating credit risk models," Working Papers in Applied Economic Theory 99-06, Federal Reserve Bank of San Francisco.
  2. Fisher, Lawrence, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 625-27, July.
  3. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
  4. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
  5. Patricia Jackson & David Maude & William Perraudin, 1998. "Bank Capital and Value at Risk," Bank of England working papers 79, Bank of England.
  6. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
  7. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
  8. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-25, July.
  9. Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
  10. Mingo, John J., 2000. "Policy implications of the Federal Reserve study of credit risk models at major US banking institutions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 15-33, January.
  11. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
  12. Jackson, Patricia & Perraudin, William, 2000. "Regulatory implications of credit risk modelling," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 1-14, January.
  13. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 39-69.
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