An Analytical Value-at-Risk Approach for a Credit Portfolio with Liquidity Horizon and Portfolio Rebalancing

28 Pages Posted: 16 Jun 2016

See all articles by Haohan Huang

Haohan Huang

York University; RBC Financial Group

Eugene Wang

RBC Financial Group

Huang Huaxiong

York University - Department of Mathematics and Statistics

Yong Wang

Everbright Securities Company Limited

Date Written: November 25, 2015

Abstract

We provide a two-period analytical value-at-risk (VaR) approach for the credit portfolio with liquidity horizon and the constant level of risk. Given any time horizon, a two-period credit portfolio loss model is derived and, at the end of the first period, the portfolio is rebalanced to ensure a constant level risk of the portfolio measured by the credit rating. The analyticalVaR is found by extending the granularity adjustment (GA) approximation. The model is applied to incremental risk charge (IRC), with the liquidity horizon of each asset being six months. By testing with the Monte Carlo simulation model, it is shown that the accuracy of the analytic model is acceptable over a large range of parameters. The model behaves similarly to the standard GA in capturing the concentration risk. We also show the features of liquidity horizon and constant level of risk are captured adequately in the model. Our analytical approach behaves better than the standard one-period asymptotic single-risk-factor model with and without GA, to achieve a comparable measure to the IRC.

Keywords: analytical value-at-risk, granularity adjustment, incremental risk charge, portfolio rebalancing, liquidity horizon

Suggested Citation

Huang, Haohan and Wang, Eugene and Huaxiong, Huang and Wang, Yong, An Analytical Value-at-Risk Approach for a Credit Portfolio with Liquidity Horizon and Portfolio Rebalancing (November 25, 2015). Journal of Credit Risk, Vol. 11, No. 4, 2015. Available at SSRN: https://ssrn.com/abstract=2795550

Haohan Huang (Contact Author)

York University ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

RBC Financial Group ( email )

Canada

Eugene Wang

RBC Financial Group ( email )

Canada

Huang Huaxiong

York University - Department of Mathematics and Statistics ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
United States

Yong Wang

Everbright Securities Company Limited ( email )

1508 Xinzha Road, 20th Floor
Jing’an District
Shanghai, 200040
China

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