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Measuring Default Risk For A Portfolio Of Equities

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  • MATHEUS PIMENTEL RODRIGUES

    (Sao Paulo School of Economics, FGV, Itapeva St., 474 Sao Paulo, SP, Brazil)

  • ANDRE CURY MAIALY

    (Sao Paulo School of Economics, FGV, Itapeva St., 474 Sao Paulo, SP, Brazil)

Abstract

This work evaluates some changes proposed by the Basel Committee on Banking Supervision in regulating capital allocation in the trading book for equities following a company default. In the last decade, the committee designed some measures to account for the risk of a company default that the ten-day value-at-risk measure does not capture. The first and more conservative measure designed to capture the effect of defaults was the incremental risk charge. With time, this measure evolved into the default risk charge. We use a Merton model to compute the probability of default and compare this probability to simulated asset returns in order to compute the one-year value-at-risk and capture the risk of a company default. The analysis compares portfolios of Ibovespa companies and S&P 500 companies. Additionally, we propose a method to account for the correlation in the companies and compare the effects of the standard method of capital allocation to those of our models.

Suggested Citation

  • Matheus Pimentel Rodrigues & Andre Cury Maialy, 2019. "Measuring Default Risk For A Portfolio Of Equities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(01), pages 1-21, February.
    • Handle: RePEc:wsi:ijtafx:v:22:y:2019:i:01:n:s0219024919500122
    DOI: 10.1142/S0219024919500122
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    References listed on IDEAS

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    4. Laurent, Jean-Paul & Sestier, Michael & Thomas, Stéphane, 2016. "Trading book and credit risk: How fundamental is the Basel review?," Journal of Banking & Finance, Elsevier, vol. 73(C), pages 211-223.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    6. Tzahi Yavin & Hu Zhang & Eugene Wang & Michael A. Clayton, 2011. "Transition Probability Matrix Methodology for Incremental Risk Charge," Papers 1102.3857, arXiv.org.
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