Modelling and Calibration Errors in Measures of Portfolio Credit Risk

42 Pages Posted: 25 Sep 2007

See all articles by Nikola A. Tarashev

Nikola A. Tarashev

Bank for International Settlements (BIS) - Monetary and Economic Department

Haibin Zhu

Bank for International Settlements (BIS)

Abstract

This paper develops an empirical procedure for analyzing the impact of model misspecification and calibration errors on measures of portfolio credit risk. When applied to large simulated portfolios with realistic characteristics, this procedure reveals that violations of key assumptions of the well-known Asymptotic Single-Risk Factor (ASRF) model are virtually inconsequential. By contrast, flaws in the calibrated interdependence of credit risk across exposures, which are driven by plausible small-sample estimation errors or popular rule-of-thumb values of asset return correlations, can lead to significant inaccuracies in measures of portfolio credit risk. Similar inaccuracies arise under erroneous, albeit standard, assumptions regarding the tails of the distribution of asset returns.

Keywords: ated defaults, value at risk, multiple common factors, granularity, estimation error, tail dependence, bank capital

JEL Classification: G21, G28, G13, C15

Suggested Citation

Tarashev, Nikola A. and Zhu, Haibin, Modelling and Calibration Errors in Measures of Portfolio Credit Risk. BIS Working Paper No. 230, Available at SSRN: https://ssrn.com/abstract=1013992

Nikola A. Tarashev (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Haibin Zhu

Bank for International Settlements (BIS) ( email )

Hong Kong
Hong Kong
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