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Improved Modeling of Double Default Effects in Basel II - An Endogenous Asset Drop Model without Additional Correlation

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  • Ebert, Sebastian
  • Lütkebohmert, Eva

Abstract

In 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

Suggested Citation

  • Ebert, Sebastian & Lütkebohmert, Eva, 2009. "Improved Modeling of Double Default Effects in Basel II - An Endogenous Asset Drop Model without Additional Correlation," Bonn Econ Discussion Papers 24/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:242009
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    References listed on IDEAS

    as
    1. 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.
    2. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank.
    3. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    4. 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.
    5. Ebert, Sebastian & Lütkebohmert, Eva, 2009. "Treatment of Double Default Effects within the Granularity Adjustment for Basel II," Bonn Econ Discussion Papers 10/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    6. Norah Barger & Erik Heitfield, 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.).
    7. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
    8. Gordy, Michael B., 2002. "Saddlepoint approximation of CreditRisk+," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1335-1353, July.
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    More about this item

    Keywords

    Basel II; double default; IRB approach; regulatory capital; structural credit portfolio models;
    All these keywords.

    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

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