Default Risk Charge: Modeling Framework for the 'Basel' Risk Measure
Journal of Risk, Vol. 19, No. 4, 2017, pp. 23-50.
Posted: 2 Aug 2015 Last revised: 31 Mar 2017
Date Written: March 30, 2017
Revised standards for capital requirements for market risks in a bank’s trading book have been issued as a result of the Fundamental Review of the Trading Book. Under the new standards, default risk needs to be measured and capitalized through a dedicated Default Risk Charge (DRC). While quantitative impact studies are ongoing and banks are preparing for these regulatory changes, this paper is the first to present a modeling framework for the DRC measure that projects losses over a one-year capital horizon at a 99.9% confidence level. The article discusses selected risk factor models to derive simulation-based loss distributions and the associated default risk figures. Model properties, implementation aspects and a comparison to the Standardised Approach for default risk are explored through the use of example portfolios.
Keywords: Banking Regulation; Risk Modeling; Market Risk; Fundamental Review of the Trading Book; Default Risk Charge
JEL Classification: G13, G18
Suggested Citation: Suggested Citation