Probability of Default Uncertainty in the Vasicek Credit Risk Framework

24 Pages Posted: 11 Apr 2016

Date Written: April 8, 2016

Abstract

After the recent financial crisis (2007-2010), many doubts on the reliability of the mathematical models to measure the financial risks have arisen. As a consequence, model risk has been a source of concern for financial regulators. This risk includes, among others, incorrect mathematical modelling, inaccurate model inputs calibration or inappropriate model application. In this paper we explore the possible effects of the uncertainty in the calibrated probability of default (PD) on the Basel capital requirements. We also propose two approximated formulas to account for the effect of this uncertainty on, respectively, single and multiple correlated portfolios. Using S&P data and a portfolio of European sovereign bonds, our main empirical conclusion is that the PD uncertainty has not a relevant impact on the risk measurement.

Keywords: Credit risk, model risk, parameter uncertainty, Vasicek model, Basel capital requirement

JEL Classification: C15, C63, G21

Suggested Citation

García-Céspedes, Rubén and Moreno Fuentes, Manuel, Probability of Default Uncertainty in the Vasicek Credit Risk Framework (April 8, 2016). Available at SSRN: https://ssrn.com/abstract=2761013 or http://dx.doi.org/10.2139/ssrn.2761013

Rubén García-Céspedes (Contact Author)

BBVA ( email )

Calle Sauceda 28, Edf Am. Norte, Plt 1ª
Madrid, Madrid 28050
Spain

Manuel Moreno Fuentes

University of Castilla-La Mancha ( email )

Cobertizo San Pedro Martir s/n
Toledo, Toledo 45071
Spain

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