Monte Carlo Simulation of Economic Capital Requirement &amp; Default Protection Premium

Kulkarni, Amit

doi:10.2139/ssrn.1094615

Cited by 1 publication

(1 citation statement)

References 20 publications

(14 reference statements)

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“…Wilson (1997) states that expected loss is illustrated as the mean of the distribution, often serves as the basis for management's reserve policies: the higher the EL, the higher the reserves required. Kulkarni (2008) states that the capital level required to cover the bank's future losses at a given confidence level is usually defined as economic capital. Repullo and Elizalde (2007) define economic capital as the capital level that bank shareholders would choose in absence of capital regulation.…”

Section: Concentrationmentioning

confidence: 99%

Concentration risk model for Greek bank's credit portfolio

Lefcaditis

Tsamis

Leventides

2014

The Journal of Risk Finance

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If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service information about how to choose which publication to write for and submission guidelines are available for all. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.comEmerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of online products and additional customer resources and services.Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation. AbstractPurpose -The IRB capital requirements of Basel II define the minimum level of capital that the bank has to retain to cover the current risks of its portfolio. The major risk that many banks are facing is credit risk and Basel II provides an approach to calculate its capital requirement. It is well known that Pillar I Basel II approach for credit risk capital requirements does not include concentration risk. The paper aims to propose a model modifying Basel II methodology (IRB) to include name concentration risk. Design/methodology/approach -The model is developed on data based on a portfolio of Greek companies that are financed by Greek commercial banks. Based on the initial portfolio, new portfolios were simulated having a range of different credit risk parameters. Subsequently, the credit VaR of various portfolios was regressed against the credit risk indicators such as Basel II capital requirements, modified Herfindahl Index and a non-linear model was developed. This model modifies the Pillar I IRB capital requirements model of Basel II to include name concentration risk. Findings -As the Pillar I IRB capital requirements model of Basel II does not include concentration risk, the credit VaR calculations performed in the present work appeared to have gaps with the Basel II capital requirements. These gaps were more apparent when there was high concentration risk in the credit portfolios. The new model bridges this gap providing with a correction coefficient. Practical implications -The credit VaR of a loan portfolio could be calculated from the bank easily, without the use of additional complicated algorithms and systems. Originality/value -The model is constructed in such a way as to provide an approximation of credit VaR satisfactory for business loan portfolios whose risk parameters lie within the range of those in a realistic bank credit portfolio and without the application of Monte Carlo simulations.

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Section: Concentrationmentioning

confidence: 99%