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Incremental Risk Charge Methodology

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  • Xiao, Tim

Abstract

The incremental risk charge (IRC) is a new regulatory requirement from the Basel Committee in response to the recent financial crisis. Notably few models for IRC have been developed in the literature. This paper proposes a methodology consisting of two Monte Carlo simulations. The first Monte Carlo simulation simulates default, migration, and concentration in an integrated way. Combining with full re-valuation, the loss distribution at the first liquidity horizon for a subportfolio can be generated. The second Monte Carlo simulation is the random draws based on the constant level of risk assumption. It convolutes the copies of the single loss distribution to produce one year loss distribution. The aggregation of different subportfolios with different liquidity horizons is addressed. Moreover, the methodology for equity is also included, even though it is optional in IRC.

Suggested Citation

  • Xiao, Tim, 2018. "Incremental Risk Charge Methodology," arabixiv.org qmcdz, Center for Open Science.
    • Handle: RePEc:osf:arabix:qmcdz
    DOI: 10.31219/osf.io/qmcdz
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    1. Xiao, Tim, 2018. "Incremental Risk Charge Methodology," SocArXiv y43dx, Center for Open Science.
    2. Dirk Tasche, 2004. "The single risk factor approach to capital charges in case of correlated loss given default rates," Papers cond-mat/0402390, arXiv.org, revised Feb 2004.
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    Cited by:

    1. Xiao, Tim, 2018. "Incremental Risk Charge Methodology," SocArXiv y43dx, Center for Open Science.
    2. 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.

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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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