Asset return correlation in Basel II: implications for credit risk management
No 04-017.RS, Working Papers CEB from ULB -- Universite Libre de Bruxelles
The Basel Committee is currently reviewing the Accord on capital adequacy. It should provide new approaches that are more sensitive to risks. This paper focuses on the Internal Rating Based Advanced approach for retail exposures, which is compared to a one systematic factor model in order to highlight the underlying hypotheses of Basel II. The Basel framework assumes that the asset return correlation is solely determined by the probability of default (PD). However, the one-factor model highlights the influence of the volatility of PD on the asset return correlation, especially for low PDs. The assumption of the Basel framework implies first that there may be opportunities for regulatory arbitrage. Second, as the regulatory capital curve is concave in PD, it gives an incentive to decompose the portfolio into segments only for reducing the capital requirement. Finally, the inaccurate measure of asset return correlation might be misleading for credit risk management. The Basel framework is applied to a large portfolio of retail contracts (35,787 individual automotive lease contracts) provided from a major European financial institution. We show that the outcomes of Basel II are empirically relevant.
Keywords: credit risk; Basle II; asset correlation (search for similar items in EconPapers)
JEL-codes: G11 G18 (search for similar items in EconPapers)
Pages: 34 p.
New Economics Papers: this item is included in nep-bec, nep-fin, nep-fmk, nep-reg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Published by: Université Libre de Bruxelles, Solvay Business School, Centre Emile Bernheim (CEB)
Downloads: (external link)
https://dipot.ulb.ac.be/dspace/bitstream/2013/14627/1/rou-0222.pdf rou-0222 (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:sol:wpaper:04-017
Ordering information: This working paper can be ordered from
http://hdl.handle.ne ... ulb.ac.be:2013/14627
Access Statistics for this paper
More papers in Working Papers CEB from ULB -- Universite Libre de Bruxelles Contact information at EDIRC.
Bibliographic data for series maintained by Benoit Pauwels ().