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Incremental Risk Charge Methodology

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  • Xiao, Tim

Abstract

The incremental risk charge (IRC) is a new regulatory requirement from the Basel Committee in response to the recent financial crisis. Notably few models for IRC have been developed in the literature. This paper proposes a methodology consisting of two Monte Carlo simulations. The first Monte Carlo simulation simulates default, migration, and concentration in an integrated way. Combining with full re-valuation, the loss distribution at the first liquidity horizon for a subportfolio can be generated. The second Monte Carlo simulation is the random draws based on the constant level of risk assumption. It convolutes the copies of the single loss distribution to produce one year loss distribution. The aggregation of different subportfolios with different liquidity horizons is addressed. Moreover, the methodology for equity is also included, even though it is optional in IRC.

Suggested Citation

  • Xiao, Tim, 2019. "Incremental Risk Charge Methodology," MPRA Paper 94581, University Library of Munich, Germany, revised 08 May 2019.
    • Handle: RePEc:pra:mprapa:94581
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    References listed on IDEAS

    as
    1. Xiao, Tim, 2018. "Incremental Risk Charge Methodology," FrenXiv 6b3hu, Center for Open Science.
    2. Dirk Tasche, 2004. "The single risk factor approach to capital charges in case of correlated loss given default rates," Papers cond-mat/0402390, arXiv.org, revised Feb 2004.
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    Cited by:

    1. Xiao, Tim, 2018. "Incremental Risk Charge Methodology," SocArXiv y43dx, Center for Open Science.
    2. Matheus Pimentel Rodrigues & Andre Cury Maialy, 2019. "Measuring Default Risk For A Portfolio Of Equities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(01), pages 1-21, February.

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    More about this item

    Keywords

    Incremental risk charge (IRC); constant level of risk; liquidity horizon; constant loss distribution; Merton-type model; concentration.;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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