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Private Equity and Regulatory Capital

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Author Info

  • Bongaerts, D.
  • Charlier, E.

    (Tilburg University, Center for Economic Research)

Abstract

Regulatory Capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the Capital Requirements Directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under the simple risk weight approach, the PD/LGD approach and the internal model approach. For the latter we present a structural model for which we calibrate the parameters from a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of these investments. We also show how to implement the early default features of our model in a simulation algorithm with very low computational costs. Our results support capital requirements lower than in Basel II, but not as low as in CRD. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios. This is likely to give adverse incentives to banks for using advanced risk models.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2008-52.

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Date of creation: 2008
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Handle: RePEc:dgr:kubcen:200852

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Web page: http://center.uvt.nl

Related research

Keywords: Private Equity; Regulatory Capital; Risk Management;

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References

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  1. Pierre Collin-Dufresne, 2001. "Do Credit Spreads Reflect Stationary Leverage Ratios?," Journal of Finance, American Finance Association, vol. 56(5), pages 1929-1957, October.
  2. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
  3. Alexander Ljungqvist & Matthew Richardson, 2003. "The cash flow, return and risk characteristics of private equity," NBER Working Papers 9454, National Bureau of Economic Research, Inc.
  4. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-64, May.
  5. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
  6. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
  7. Brent Ambrose & Michael LaCour-Little & Anthony Sanders, 2005. "Does Regulatory Capital Arbitrage, Reputation, or Asymmetric Information Drive Securitization?," Journal of Financial Services Research, Springer, vol. 28(1), pages 113-133, October.
  8. Steven Kaplan & Antoinette Schoar, 2003. "Private Equity Performance: Returns, Persistence and Capital," NBER Working Papers 9807, National Bureau of Economic Research, Inc.
  9. Kaserer, Christoph & Diller, Christian, 2004. "What drives cash flow based European private equity returns? Fund inflows, skilled GPs and/or risk?," CEFS Working Paper Series 2004-02, Center for Entrepreneurial and Financial Studies (CEFS), Technische Universit√§t M√ľnchen.
  10. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  11. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
  12. Kaplan, Steve & Schoar, Antoinette, 2004. "Private Equity Performance: Returns, Persistence and Capital Flows," Working papers 4446-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  13. Alexander Ljungqvist & Matthew Richardson & Daniel Wolfenzon, 2008. "The Investment Behavior of Buyout Funds: Theory and Evidence," NBER Working Papers 14180, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Phalippou, Ludovic, 2010. "Venture capital funds: Flow-performance relationship and performance persistence," Journal of Banking & Finance, Elsevier, vol. 34(3), pages 568-577, March.
  2. Cardone-Riportella, Clara & Samaniego-Medina, Reyes & Trujillo-Ponce, Antonio, 2010. "What drives bank securitisation? The Spanish experience," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2639-2651, November.
  3. Kerkhof, Jeroen & Melenberg, Bertrand & Schumacher, Hans, 2010. "Model risk and capital reserves," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 267-279, January.
  4. Groh, Alexander Peter & Gottschalg, Oliver, 2011. "The effect of leverage on the cost of capital of US buyouts," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2099-2110, August.
  5. Nikola Tarashev, 2009. "Measuring portfolio credit risk correctly: why parameter uncertainty matters," BIS Working Papers 280, Bank for International Settlements.

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