Measuring business sector concentration by an infection model
Results from portfolio models for credit risk tell us that loan concentration in certain industry sectors can substantially increase the value-at-risk (VaR). The purpose of this paper is to analyze whether a tractable "infection model" can provide a meaningful estimate of the impact of concentration risk on the VaR. I apply rather parsimonious data requirements, which are comparable to those for Moody's Binomial Expansion Technique (BET) and considerably lower than for a multi-factor model. The infection model extends the BET model by introducing default infection into the hypothetical portfolio on which the real portfolio is mapped in order to obtain a simple solution for the VaR. The infection probability is calibrated for a range of typical values of input parameters, which capture the concentration of a portfolio in industry sectors, default dependencies between exposures and their credit quality. The accuracy of the new model is measured for test portfolios with a realistic industry-sector composition, obtained from the German central credit register. I find that a carefully calibrated infection model provides a reasonably close approximation to the VaR obtained from a multi-factor model and outperforms by far the BET model. The simulation results suggest that the calibrated infection model promises to provide a fit-for-purpose tool to measure concentration risk in business sectors that could be useful for risk managers and banking supervisors alike.
|Date of creation:||2006|
|Contact details of provider:|| Postal: Postfach 10 06 02, 60006 Frankfurt|
Phone: 0 69 / 95 66 - 34 55
Fax: 0 69 / 95 66 30 77
Web page: http://www.bundesbank.de/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:zbw:bubdp2:4359. 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: (ZBW - German National Library of Economics)
If references are entirely missing, you can add them using this form.