Measuring Default Risk for a Portfolio of Equities

17 Pages Posted: 8 Dec 2017 Last revised: 23 Jul 2018

See all articles by Matheus Rodrigues

Matheus Rodrigues

Universidade de Sao Paulo

Andre Maialy

University of São Paulo (USP)

Date Written: July 13, 2018

Abstract

This work evaluates some changes proposed by the Basel committee (BCBS) regulation for capital allocation in the trading book due to a company default in an equities portfolio. In the last decade, some measures were designed to account for the risk of default of a company, which were not caught by a 10-day value at risk measure. The first and more conservative measure designed to capture the effect of defaults was the incremental risk charge. With time, this measure went through some changes until it became the default risk charge. To design these measures, we used a Merton model to compute the probability of default. This probability is compared with the simulated asset returns to compute a 1-year value at risk. The idea is to capture the risk of a company defaulting. The results shown are based in a portfolio of Ibovespa companies and a portfolio of S\&P 500 companies. Additionally, we propose a manner to account for the correlation in the companies, and we compare the effects of the standard method of capital allocation to the models developed in this study.

Keywords: FRTB; default risk; equities; multi-factor model

Suggested Citation

Rodrigues, Matheus and Maialy, Andre, Measuring Default Risk for a Portfolio of Equities (July 13, 2018). Available at SSRN: https://ssrn.com/abstract=3082021 or http://dx.doi.org/10.2139/ssrn.3082021

Matheus Rodrigues (Contact Author)

Universidade de Sao Paulo ( email )

Brazil

Andre Maialy

University of São Paulo (USP) ( email )

Brazil

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