Title: Trading Book and Credit Risk: How Fundamental is the Basel Review?
Abstract: In its October 2013’s consultative paper for a revised market risk framework (FRTB), and subsequent versions published thereafter, the Basel Committee suggests that non-securitization credit positions in the trading book be subject to a separate Default Risk Charge (DRC, formally Incremental Default Risk charge or IDR). This evolution is an attempt to overcome practical challenges raised by the current Basel 2.5 Incremental Risk Charge (IRC). Banks using the internal model approach would no longer have the choice of using either a single-factor or a multi-factor default risk model but instead, market risk rules would require the use of a two-factor simulation model and a 99.9%-VaR capital charge. In this article, we analyze the theoretical foundations of these proposals, particularly the link with the one-factor model used for the banking book and with a general J-factor setting. We thoroughly investigate the practical implications of the two-factor and the correlation calibration constraints through numerical applications. We introduce the Hoeffding decomposition of the aggregate unconditional loss to provide a systematic-idiosyncratic representation. Impacts of a J-factor correlation structure on risk measures and risk contributions are studied for long-only and long-short credit-sensitive portfolios.
Publication Year: 2015
Publication Date: 2015-01-01
Language: en
Type: article
Indexed In: ['crossref']
Access and Citation
Cited By Count: 7
AI Researcher Chatbot
Get quick answers to your questions about the article from our AI researcher chatbot