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

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  • Lucas, Andre
  • Klaassen, Pieter
  • Spreij, Peter
  • Straetmans, Stefan

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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Suggested Citation

  • Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001. "An analytic approach to credit risk of large corporate bond and loan portfolios," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1635-1664, September.
    • Handle: RePEc:eee:jbfina:v:25:y:2001:i:9:p:1635-1664
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other

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