A Credit Risk Model for Large Dimensional Portfolios with Application to Economic Capital

Posted: 28 Mar 2013

Date Written: March 25, 2006

Abstract

In this paper we develop a multi-period and multi-state portfolio credit risk model which is applicable to large dimensional portfolios like for example retail and mortgage portfolios. The model includes a methodology for estimation and simulation of systematic transition risk through a model for stochastic migration, a methodology for the modelling of recoveries in the case of stochastic collaterals as well as an approach to dimension reduction of the portfolio. One important application of our model is economic capital (EC) and a concept of EC based on the analogy with classical risk theory is introduced and the questions of allocation as well as risk-adjusted pricing based on the allocation of EC are structured and described. The model is illustrated by an extensive numerical example giving a concretization of the model as well as of several of the concepts introduced.

Keywords: Portfolio credit risk, large credit portfolios, credit risk model framework, credit risk economic capital, credit loss projections

Suggested Citation

Skoglund, Jimmy and Nyström, Kaj, A Credit Risk Model for Large Dimensional Portfolios with Application to Economic Capital (March 25, 2006). Journal of Banking and Finance, Vol. 30, 2006, Available at SSRN: https://ssrn.com/abstract=2239053

Jimmy Skoglund (Contact Author)

SAS Institute Inc. ( email )

100 SAS Campus Drive
Cary, NC 27513-2414
United States

Kaj Nyström

University of Umea ( email )

Samhallsvetarhuset, Plan 2
Umea University
Umeå, SE 901 87
Sweden

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