Granularity adjustment for mark-to-market credit risk models

Michael Gordy and James Marrone

No 2010-37, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The impact of undiversified idiosyncratic risk on value-at-risk and expected shortfall can be approximated analytically via a methodology known as granularity adjustment (GA). In principle, the GA methodology can be applied to any risk-factor model of portfolio risk. Thus far, however, analytical results have been derived only for simple models of actuarial loss, i.e., credit loss due to default. We demonstrate that the GA is entirely tractable for single-factor versions of a large class of models that includes all the commonly used mark-to-market approaches. Our approach covers both finite ratings-based models and models with a continuum of obligor states. We apply our methodology to CreditMetrics and KMV Portfolio Manager, as these are benchmark models for the finite and continuous classes, respectively. Comparative statics of the GA with respect to model parameters in CreditMetrics reveal striking and counterintuitive patterns. We explain these relationships with a stylized model of portfolio risk.

Keywords: Risk management; Econometric models (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-ban and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.federalreserve.gov/pubs/feds/2010/201037/201037abs.html (text/html)
http://www.federalreserve.gov/pubs/feds/2010/201037/201037pap.pdf (application/pdf)

Related works:
Journal Article: Granularity adjustment for mark-to-market credit risk models (2012)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2010-37

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().