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Precautionary Measures for Credit Risk Management in Jump Models

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  • Masahiko Egami
  • Kazutoshi Yamazaki

Abstract

Sustaining efficiency and stability by properly controlling the equity to asset ratio is one of the most important and difficult challenges in bank management. Due to unexpected and abrupt decline of asset values, a bank must closely monitor its net worth as well as market conditions, and one of its important concerns is when to raise more capital so as not to violate capital adequacy requirements. In this paper, we model the tradeoff between avoiding costs of delay and premature capital raising, and solve the corresponding optimal stopping problem. In order to model defaults in a bank’s loan/credit business portfolios, we represent its net worth by appropriate L´evy processes, and solve explicitly for the double exponential jump diffusion process. In particular, for the spectrally negative case, we generalize the formulation using the scale function, and obtain explicitly the optimal solutions for the exponential jump diffusion process.

Suggested Citation

  • Masahiko Egami & Kazutoshi Yamazaki, 2010. "Precautionary Measures for Credit Risk Management in Jump Models," Discussion papers e-10-001, Graduate School of Economics Project Center, Kyoto University.
    • Handle: RePEc:kue:dpaper:e-10-001
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    References listed on IDEAS

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    Cited by:

    1. Tim Siu-Tang Leung & Kazutoshi Yamazaki, 2010. "American Step-Up and Step-Down Default Swaps under Levy Models," Papers 1012.3234, arXiv.org, revised Sep 2012.
    2. Egami, Masahiko & Leung, Tim & Yamazaki, Kazutoshi, 2013. "Default swap games driven by spectrally negative Lévy processes," Stochastic Processes and their Applications, Elsevier, vol. 123(2), pages 347-384.

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