Semi-analytical implementation for the name concentration measurement in a credit portfolio

Abstract

Basel II is the second of the Basel Accords, which are recommendations on banking regulations issued by the Basel Committee on Banking Supervision. We concentrate in credit risk, which is the most important risk a bank has to deal with.

Basel II is structured in a three pillar framework. The Pillar one capital charge for credit risk is based on the Asymptotic Single-Risk Factor model. One of its important assumptions is that a portfolio is well diversified, this is, there is no name concentration among obligors in the credit portfolio. In the real world, however, this main assumption is violated and then the measured risk can be underestimated.

Monte Carlo method is a standard method for measuring credit portfolio risk in order to deal with exposure concentration. However, this method is known to be very time consuming making the approximation impractical in many situations, over all when the size of the portfolio increases. For this main reason, any analytical method is welcome.

This project focuses on the study and implementation of a semi-analytical technique to measure the name concentration of a credit portfolio.. The capital charge for credit risk is based on the asymptotic single-risk factor model. One of its important assumptions is that a portfolio is well diversified. However, this main assumption is violated frequently and then the risk measured can be underestimated. Monte Carlo (MC) method is a standard method for measuring credit portfolio risk in order to deal with exposure concentration but it is computationally intensive. In this project, we study a semi-analytical technique to be used instead of MC.