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Failure of saddle-point method in the presence of double defaults

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  • Lütkebohmert, Eva

Abstract

We show that the saddle-point approximation method to quantify the impact of undiversi?ed idiosyncratic risk in a credit portfolio is inappropriate in the presence of double default effects. Speci?cally, we prove that there does not exist an equivalent formula to the granularity adjustment, that accounts for guarantees, in case of the extended single-factor CreditRisk+ model. Moreover, in case of the model underlying the double default treatment within the internal ratings based (IRB) approach of Basel II, the saddle-point equivalent to the GA is too complex and involved to be competitive to a standard Monte Carlo approach.

Suggested Citation

  • Lütkebohmert, Eva, 2009. "Failure of saddle-point method in the presence of double defaults," Bonn Econ Discussion Papers 19/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:192009
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    References listed on IDEAS

    as
    1. Peter Grundke, 2008. "Regulatory treatment of the double default effect under the New Basel Accord: how conservative is it?," Review of Managerial Science, Springer, vol. 2(1), pages 37-59, March.
    2. Lütkebohmert, Eva & Gordy, Michael B., 2007. "Granularity adjustment for Basel II," Discussion Paper Series 2: Banking and Financial Studies 2007,01, Deutsche Bundesbank.
    3. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    4. Ebert, Sebastian & Lütkebohmert, Eva, 2009. "Treatment of Double Default Effects within the Granularity Adjustment for Basel II," Bonn Econ Discussion Papers 10/2009, University of Bonn, Bonn Graduate School of Economics (BGSE).
    5. Norah Barger & Erik Heitfield, 2003. "Treatment of double-default and double-recovery effects for hedged exposures under pillar I of the proposed New Basel Capital Accord," Basel II White Paper 2, Board of Governors of the Federal Reserve System (U.S.).
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    analytical approximation; Basel II; double default; granularity adjustment; IRB approach; saddle-point approximation;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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