Calculating Capital Charges for Sector Concentration Risk

34 Pages Posted: 22 Oct 2018

See all articles by Cornelius Kurtz

Cornelius Kurtz

European Central Bank (ECB)

Eva Luetkebohmert

University of Freiburg, Institute for Economic Research; affiliation not provided to SSRN

Julian Sester

University of Freiburg; Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences

Date Written: October 18, 2018

Abstract

We propose a methodology to quantify capital charges for concentration risk when economic capital calculations are conducted within a multifactor Merton framework. The concentration charge is defined through the impact of the sector on the portfolio loss curve. We propose two ways of measuring this effect. The first method relies on Monte Carlo simulation but has the advantage of not requiring the calibration of additional parameters and, hence, is easily applicable to banks that perform simulations. The second approach is a tractable, analytical formula that provides an efficient approximation to the first method. The proposed approach implies a simple and intuitive allocation of the resultant capital charge and is highly suitable to calculate capital charges for sector concentration risk under Pillar 2 of the Basel regulatory framework.

Keywords: credit risk, sector concentration risk, capital allocation, analytical approximation, Monte Carlo simulation

Suggested Citation

Kurtz, Cornelius and Luetkebohmert, Eva and Sester, Julian and Sester, Julian, Calculating Capital Charges for Sector Concentration Risk (October 18, 2018). Journal of Credit Risk, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3269265

Cornelius Kurtz

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Eva Luetkebohmert

University of Freiburg, Institute for Economic Research ( email )

Rempartstr. 16
Freiburg, D-79098
Germany

affiliation not provided to SSRN

Julian Sester (Contact Author)

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

University of Freiburg

Freiburg, D-79085
Germany

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