Using Expected Shortfall for Credit Risk Regulation
Kjartan Kloster Osmundsen
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Kjartan Kloster Osmundsen: UiS, Postal: University of Stavanger, NO-4036 Stavanger, Norway
No 2017/4, UiS Working Papers in Economics and Finance from University of Stavanger
The Basel Committee’s minimum capital requirement function for banks’ credit risk is based on value at risk. This paper performs a statistical and economic analysis of the consequences of instead basing it on expected shortfall, a switch that has already been set in motion for market risk. The empirical analysis is carried out by means of both theoretical simulations and real data from a Norwegian savings bank group’s corporate portfolio. Expected shortfall has some well known conceptual advantages compared to value at risk, primarily a better ability to capture tail risk. It is also sub-additive in gen- eral, thus always reflecting the positive effect of diversification. These two aspects are examined in detail, in addition to comparing parameter sensitivity, estimation stabil- ity and backtesting methods for the two risk measures. All comparisons are conducted within the Basel Committee’s minimum capital requirement framework. The findings support a switch from value at risk to expected shortfall for credit risk modelling.
Keywords: Expected shortfall; credit risk; bank regulation; Basel III; tail risk (search for similar items in EconPapers)
JEL-codes: G10 (search for similar items in EconPapers)
Pages: 30 pages
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:stavef:2017_004
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