Improved Modeling of Double Default Effects in Basel II - An Endogenous Asset Drop Model without Additional Correlation
AbstractIn 2005 the Internal Ratings Based (IRB) approach of `Basel II' was enhanced by a `treatment of double default effects' to account for credit risk mitigation techniques such as ordinary guarantees or credit derivatives. This paper reveals several severe problems of this approach and presents a new method to account for double default effects. This new it asset drop technique can be applied within any structural model of portfolio credit risk. When formulated within the IRB approach of Basel II, it is very well suited for practical application as it does not pose extensive data requirements and economic capital can still be computed
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse24_2009.
Date of creation: Oct 2009
Date of revision:
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Basel II; double default; IRB approach; regulatory capital; structural credit portfolio models;
Find related papers by JEL classification:
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-11-07 (All new papers)
- NEP-BAN-2009-11-07 (Banking)
- NEP-RMG-2009-11-07 (Risk Management)
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- Erik Heitfield & Norah Barger, 2003. "Treatment of double-default and double-recovery effects for hedged exposures under pillar I of the proposed New Basel Capital Accord," Basel II White Paper 2, Board of Governors of the Federal Reserve System (U.S.).
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- Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.).
- Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank, Research Centre.
- Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
- Gordy, Michael B., 2002. "Saddlepoint approximation of CreditRisk+," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1335-1353, July.
- Peter Grundke, 2008. "Regulatory treatment of the double default effect under the New Basel Accord: how conservative is it?," Review of Managerial Science, Springer, vol. 2(1), pages 37-59, March.
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