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The measure of model risk in credit capital requirements

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  • Baviera, Roberto

Abstract

Credit capital requirements in Internal Rating Based approaches require the calibration of two key parameters: the probability of default and the loss-given-default. This letter considers the uncertainty about these two parameters and models this uncertainty in an elementary way: it shows how this estimation risk can be computed and properly taken into account in regulatory capital.

Suggested Citation

  • Baviera, Roberto, 2022. "The measure of model risk in credit capital requirements," Finance Research Letters, Elsevier, vol. 44(C).
    • Handle: RePEc:eee:finlet:v:44:y:2022:i:c:s1544612321001458
    DOI: 10.1016/j.frl.2021.102064
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    References listed on IDEAS

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    7. Henri Fraisse & Mathias Lé & David Thesmar, 2020. "The Real Effects of Bank Capital Requirements," Management Science, INFORMS, vol. 66(1), pages 5-23, January.
    8. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank.
    9. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
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    Cited by:

    1. Chai, Nana & Shi, Baofeng & Hua, Yiting, 2023. "Loss given default or default status: Which is better to determine farmers’ credit ratings?," Finance Research Letters, Elsevier, vol. 53(C).
    2. Cho, Yongbok & Lee, Yongwoong, 2022. "Asymmetric asset correlation in credit portfolios," Finance Research Letters, Elsevier, vol. 49(C).

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    More about this item

    Keywords

    Regulatory capital; estimation risk; VaR; IRB approach; LGD-PD dependency; scaling factor;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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