An analytic approach to credit risk of large corporate bond and loan portfolios
We consider portfolio credit loss distributions based on a factor model for individual exposures and establish an analytic characterization of the credit loss distribution if the number of exposures tends to infinity. Using this limiting distribution, we explain how skewness and leptokurtosis of credit loss distributions relate to the underlying factor model and the portfolio composition. A key role is played by the R2 of the factor model regression. Based on the limiting distribution and empirical data, it appears that the Basle 8% rule is not an unreasonable approximation for high confidence (99.9%) quantiles of credit losses of a typical portfolio of rated corporate bonds. The practical relevance of our results for credit risk management is investigated by checking the applicability of the limiting distribution to portfolios with a finite number of exposures. It appears that for relatively homogeneous portfolios a minimum of 300 exposures is enough, while for relatively heterogeneous portfolios a number of 800 exposures suffices to obtain an adequate approximation. Thus, our approach can be a
|Date of creation:||1999|
|Contact details of provider:|| Web page: http://www.feweb.vu.nl|
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.:
- Duffee, Gregory R., 1996.
"On measuring credit risks of derivative instruments,"
Journal of Banking & Finance,
Elsevier, vol. 20(5), pages 805-833, June.
- Gregory R. Duffee, 1994. "On measuring credit risks of derivative instruments," Finance and Economics Discussion Series 94-27, Board of Governors of the Federal Reserve System (U.S.).
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-367, May.
- 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 449-470, May.
- Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
- Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, 08.
- Chunsheng Zhou, 1997. "Default correlation: an analytical result," Finance and Economics Discussion Series 1997-27, Board of Governors of the Federal Reserve System (U.S.).
- Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:vua:wpaper:1999-18. 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: (R. Dam)
If references are entirely missing, you can add them using this form.