MEASURING DEFAULT RISK FOR A PORTFOLIO OF EQUITIES

Matheus Pimentel Rodrigues () and Andre Cury Maialy ()
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Matheus Pimentel Rodrigues: Sao Paulo School of Economics, FGV, Itapeva St., 474 Sao Paulo, SP, Brazil
Andre Cury Maialy: Sao Paulo School of Economics, FGV, Itapeva St., 474 Sao Paulo, SP, Brazil

International Journal of Theoretical and Applied Finance (IJTAF), 2019, vol. 22, issue 01, 1-21

Abstract: This work evaluates some changes proposed by the Basel Committee on Banking Supervision in regulating capital allocation in the trading book for equities following a company default. In the last decade, the committee designed some measures to account for the risk of a company default that the ten-day value-at-risk measure does not capture. The first and more conservative measure designed to capture the effect of defaults was the incremental risk charge. With time, this measure evolved into the default risk charge. We use a Merton model to compute the probability of default and compare this probability to simulated asset returns in order to compute the one-year value-at-risk and capture the risk of a company default. The analysis compares portfolios of Ibovespa companies and S&P 500 companies. Additionally, we propose a method to account for the correlation in the companies and compare the effects of the standard method of capital allocation to those of our models.

Keywords: FRTB; default risk; equities; multi-factor model (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1142/S0219024919500122

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