Asset return correlation in Basel II: implications for credit risk management
The Basel Committee is currently reviewing the Accord on capital adequacy. It should provide new approaches that are more sensitive to risks. This paper focuses on the Internal Rating Based Advanced approach for retail exposures, which is compared to a one systematic factor model in order to highlight the underlying hypotheses of Basel II. The Basel framework assumes that the asset return correlation is solely determined by the probability of default (PD). However, the one-factor model highlights the influence of the volatility of PD on the asset return correlation, especially for low PDs. The assumption of the Basel framework implies first that there may be opportunities for regulatory arbitrage. Second, as the regulatory capital curve is concave in PD, it gives an incentive to decompose the portfolio into segments only for reducing the capital requirement. Finally, the inaccurate measure of asset return correlation might be misleading for credit risk management. The Basel framework is applied to a large portfolio of retail contracts (35,787 individual automotive lease contracts) provided from a major European financial institution. We show that the outcomes of Basel II are empirically relevant.
|Date of creation:||Apr 2004|
|Date of revision:|
|Publication status:||Published by: Université Libre de Bruxelles, Solvay Business School, Centre Emile Bernheim (CEB)|
|Contact details of provider:|| Postal: |
Phone: +32 (0)2 650.48.64
Fax: +32 (0)2 650.41.88
Web page: http://difusion.ulb.ac.beEmail:
More information through EDIRC
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.:
- Stéphanie Duchemin & Marie-Paule Laurent & Mathias Schmit, 2003. "Asset return correlation: The case of automotive lease portfolios," Working Papers CEB 03-007.RS, ULB -- Universite Libre de Bruxelles.
- Schmit, Mathias, 2004. "Credit risk in the leasing industry," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 811-833, April.
- Gordy, Michael B., 2000.
"A comparative anatomy of credit risk models,"
Journal of Banking & Finance,
Elsevier, vol. 24(1-2), pages 119-149, January.
- Sironi, Andrea & Zazzara, Cristiano, 2003. "The Basel Committee proposals for a new capital accord: implications for Italian banks," Review of Financial Economics, Elsevier, vol. 12(1), pages 99-126.
- Altman, Edward I, 1989. " Measuring Corporate Bond Mortality and Performance," Journal of Finance, American Finance Association, vol. 44(4), pages 909-22, September.
When requesting a correction, please mention this item's handle: RePEc:sol:wpaper:04-017. 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: (Benoit Pauwels)
If references are entirely missing, you can add them using this form.