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Specification and Calibration Errors in Measures of Portfolio Credit Risk: The Case of the ASRF Model

  • Nikola Tarashev

    (Monetary and Economic Department, Bank for International Settlements)

  • Haibin Zhu

    (Monetary and Economic Department, Bank for International Settlements)

This paper focuses on the asymptotic single-risk-factor (ASRF) model in order to analyze the impact of specification and calibration errors on popular measures of portfolio credit risk. Violations of key assumptions of this model are found to be virtually inconsequential, especially for large, welldiversified portfolios. By contrast, flaws in the calibrated interdependence of credit risk across exposures, caused by plausible small-sample estimation errors or rule-of-thumb values of asset return correlations, can lead to significant inaccuracies in measures of portfolio credit risk. Similar inaccuracies arise under standard assumptions regarding the tails of the distribution of asset returns.

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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 2 (June)
Pages: 129-173

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Handle: RePEc:ijc:ijcjou:y:2008:q:2:a:4
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  1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
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  3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
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  5. Düllmann, Klaus & Scheicher, Martin & Schmieder, Christian, 2007. "Asset correlations and credit portfolio risk: an empirical analysis," Discussion Paper Series 2: Banking and Financial Studies 2007,13, Deutsche Bundesbank, Research Centre.
  6. Michael S. Gibson, 2004. "Understanding the risk of synthetic CDOs," Finance and Economics Discussion Series 2004-36, Board of Governors of the Federal Reserve System (U.S.).
  7. Lopez, Jose A., 2004. "The empirical relationship between average asset correlation, firm probability of default, and asset size," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 265-283, April.
  8. Samuel Hanson & M. Hashem Pesaran & Til Schuermann, 2005. "Firm Heterogeneity and Credit Risk Diversification," CESifo Working Paper Series 1531, CESifo Group Munich.
  9. Loffler, Gunter, 2003. "The effects of estimation error on measures of portfolio credit risk," Journal of Banking & Finance, Elsevier, vol. 27(8), pages 1427-1453, August.
  10. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank, Research Centre.
  11. Masschelein, Nancy & Düllmann, Klaus, 2006. "Sector concentration in loan portfolios and economic capital," Discussion Paper Series 2: Banking and Financial Studies 2006,09, Deutsche Bundesbank, Research Centre.
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