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An analytic approach to credit risk of large corporate bond and loan portfolios

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  • Lucas, André

    (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)

  • Klaassen, Pieter
  • Spreij, Peter
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    Abstract

    We consider portfolio credit loss distributions based on a factor model for individual exposures and establish an analytic characterization of the credit loss distribution if the number of exposures tends to infinity. Using this limiting distribution, we explain how skewness and leptokurtosis of credit loss distributions relate to the underlying factor model and the portfolio composition. A key role is played by the R2 of the factor model regression. Based on the limiting distribution and empirical data, it appears that the Basle 8% rule is not an unreasonable approximation for high confidence (99.9%) quantiles of credit losses of a typical portfolio of rated corporate bonds. The practical relevance of our results for credit risk management is investigated by checking the applicability of the limiting distribution to portfolios with a finite number of exposures. It appears that for relatively homogeneous portfolios a minimum of 300 exposures is enough, while for relatively heterogeneous portfolios a number of 800 exposures suffices to obtain an adequate approximation. Thus, our approach can be a

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    File URL: http://degree.ubvu.vu.nl/repec/vua/wpaper/pdf/19990018.pdf
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    Bibliographic Info

    Paper provided by VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics in its series Serie Research Memoranda with number 0018.

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    Date of creation: 1999
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    Handle: RePEc:vua:wpaper:1999-18

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    Related research

    Keywords: credit risk; factor model; fat-tailed distributions; skewness; asymptotic analysis;

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