Calibrating Your Intuition: Capital Allocation for Market and Credit Risk

May 1, 2002

Preview Citation

Format: Chicago

Paul H. Kupiec Calibrating Your Intuition: Capital Allocation for Market and Credit Risk, (USA: International Monetary Fund, 2002) accessed September 18, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Value-at-Risk (VaR) models often are used to estimate the equity investment that is required to limit the default rate on funding debt. Typical VaR "buffer stock" capital calculations produce biased estimates. To ensure accuracy, VaR must be modified by: (1) measuring loss relative to initial market value; and (2) augmenting VaR to account for the interest income required by investors. While this issue has been identified in the market risk setting, it has yet to be recognized in the credit risk literature. Credit VaR techniques, as typically described, are not an appropriate basis for setting equity capital allocations.

Subject: Credit, Credit risk, Debt financing, Market risk, Vector autoregression

Keywords: Market value, WP

Publication Details

Pages:

23
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2002/099
Stock No:

WPIEA0992002
ISBN:

9781451852288
ISSN:

1018-5941

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