Generalized Asset Value Credit Risk Models and Risk Minimality of the Classical Approach

Abstract

We place the asset value credit portfolio model in the larger context of generalized correlation models where the normal distribution assumption of asset returns is replaced by an abstract elliptical distribution.

Based on closed-form solutions for homogenous portfolios, we show in particular that the classical asset value model is not robust against misspecifications of the assumed asset return distribution, that it further systematically underestimates portfolio risk, if the asset return distribution is non-normal, and that it may also induce insufficient supply of economic capital to cover credit portfolio risk in the world's financial institutions.

Keywords: credit risk, credit portfolio modeling, credit portfolio risk, asset value model, elliptical distribution, asymptotic loss distribution, loss density, value at risk, model error, economic capital

JEL Classification: C13, C15, C16, C51, G33