Sensible and Efficient Capital Allocation for Credit Portfolios

Michael Kalkbrener · Hans Lotter · Ludger Overbeck

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Risk and Portfolio Optimization Stochastic processes and financial applications Financial Risk and Volatility Modeling

Abstract

The expected shortfall and volatility capital allocation schemes are analyzed from a formal mathematical perspective and in a simulation study. We argue that expected shortfall is the superior measure for the allocation of capital in credit portfolios. The simulation is based on a new importance sampling algorithm for Merton-type models, which greatly increases the precision of Monte-Carlo estimates.

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References

1999Coherent Measures of Risk 2000Optimization of conditional value-at-risk 2002On the coherence of expected shortfall 2000A comparative analysis of current credit risk models 2003A risk-factor model foundation for ratings-based bank capital rules 2001Coherent allocation of risk capital 2002An Introduction to Credit Risk Modeling 2000Coherent risk measures

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