The empirical relationship between average asset correlation, firm probability of default, and asset size
The asymptotic single risk factor (ASRF) approach is a simplified framework for determining regulatory capital charges for credit risk and has become an integral part of how credit risk capital requirements are to be determined under the second Basel Accord. Within this approach, a key regulatory parameter is the average asset correlation. In this paper, we examine the empirical relationship between the average asset correlation, firm probability of default and firm asset size measured by the book value of assets by imposing the ASRF approach within the KMV methodology for determining credit risk capital requirements. Using data from year-end 2000, credit portfolios consisting of U.S., Japanese and European firms are analyzed. The empirical results suggest that average asset correlation is a decreasing function of probability of default and an increasing function of asset size. When compared with the average asset correlations proposed by the Basel Committee on Banking Supervision in November 2001, the empirical average asset correlations further suggest that accounting for firm asset size, especially for larger firms, may be important. In conclusion, the empirical results suggest that a variety of factors may impact average asset correlations within an ASRF framework, and these factors may need to be accounted for in the final calculation of regulatory capital requirements for credit risk.
(This abstract was borrowed from another version of this item.)
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Simonne Varotto, 2001. "Credit Risk Diversification," ICMA Centre Discussion Papers in Finance icma-dp2001-07, Henley Business School, Reading University.
- Michael B. Gordy, 2000. "Credit VAR and risk-bucket capital rules: a reconciliation," Proceedings 685, Federal Reserve Bank of Chicago.
- Gordy, Michael B., 2000.
"A comparative anatomy of credit risk models,"
Journal of Banking & Finance,
Elsevier, vol. 24(1-2), pages 119-149, January.
- Beverly J. Hirtle & Mark Levonian & Marc Saidenberg & Stefan Walter & David Wright, 2001. "Using credit risk models for regulatory capital: issues and options," Economic Policy Review, Federal Reserve Bank of New York, issue Mar, pages 19-36.
When requesting a correction, please mention this item's handle: RePEc:eee:jfinin:v:13:y:2004:i:2:p:265-283. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If references are entirely missing, you can add them using this form.