Efficient estimation of unconditional capital by Monte Carlo simulation

Alex Ferrer (), José Casals and Sonia Sotoca

Finance Research Letters, 2016, vol. 16, issue C, 75-84

Abstract: We address the problem of determining the unconditional capital required by a credit portfolio using Monte Carlo simulation. By elaborating on a tractable analytical framework, we propose a new efficient simulation algorithm that overweights recession periods, which are the most important periods for determining the final capital figure, thereby improving its efficiency for a given number of simulations. We discuss the optimality and practical advantages of this algorithm. We also conduct an empirical analysis based on American charge-off data, which shows that the proposed algorithm achieves remarkable improvements in efficiency, without introducing any bias and at a negligible implementation cost.

Keywords: Capital estimation; Charge-off; Credit risk; Monte Carlo simulation; Unconditional capital (search for similar items in EconPapers)
JEL-codes: C58 G17 G21 G32 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:16:y:2016:i:c:p:75-84

DOI: 10.1016/j.frl.2015.10.010

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