Credit Risk and Solvency Capital Requirements
European Actuarial Journal, Vol. 8, N°2, p. 487–515, 2018
29 Pages Posted: 19 Mar 2016 Last revised: 26 Apr 2019
Date Written: March 18, 2016
This article constructs a recovery-based framework for computing the credit Solvency Capital Requirements of insurers under the constant position paradigm. Although this framework is most suited under the Solvency 2 regulation, it also provides concepts that can be useful under the Basel regulation. After a brief survey of the extant technology on rating transitions and default probabilities, the paper provides new results on risk premium adjustment factors. Then, three different procedures for reconstructing constant-position market-consistent histories of credit portfolios from quoted Merryll Lynch indices are given. The reconstructed historical credit values are then calibrated to mixed empirical-Generalized Pareto Distribution (GPD) dynamics. Several validations of the calibration are also provided. Finally, credit Solvency Capital Requirements are computed and an analysis of the results per rating class is given.
Keywords: Credit Spread, Risk Premium Adjustment Factor, Solvency Capital Requirement, General Pareto Distribution, Market Consistency, Rating Transition, Credit Benchmarking, Constant Position
JEL Classification: G10, G22
Suggested Citation: Suggested Citation