Modeling default risk charge (DRC) with intensity probability theory
The latest regulation [1] of the fundamental review of the trading book (FRTB) proposes replacing incremental risk charge (IRC) with default risk charge (DRC). Accordingly, many studies were implemented to analyze this change and its impact. Current modeling practices test several assumptions during...
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AIMS Press
2025-02-01
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| Series: | AIMS Mathematics |
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| Online Access: | https://www.aimspress.com/article/doi/10.3934/math.2025137 |
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| author | Badreddine Slime Jaspreet Singh Sahni |
| author_facet | Badreddine Slime Jaspreet Singh Sahni |
| author_sort | Badreddine Slime |
| collection | DOAJ |
| description | The latest regulation [1] of the fundamental review of the trading book (FRTB) proposes replacing incremental risk charge (IRC) with default risk charge (DRC). Accordingly, many studies were implemented to analyze this change and its impact. Current modeling practices test several assumptions during conception and implementation. However, these assumptions impact model output and sometimes do not reflect market behavior. Two common assumptions used in DRC modeling in the literature are: (ⅰ) the default is implemented in a structural model (e.g., the Merton model) and (ⅱ) correlations between issuers follow the Gaussian copula. Notably, the Merton model does not pick up defaults for positions with a very small probability of default or instant default. Therefore, the structural approach results in a model risk that is not conservative enough to cover the DRC risk. In this paper, we compared an intensity model (CreditRisk+) to a structural model (Merton) to assess their impact on DRC and quantify the risk generated by the first assumption. |
| format | Article |
| id | doaj-art-cf102f233f0a48f28feb055dd2115521 |
| institution | OA Journals |
| issn | 2473-6988 |
| language | English |
| publishDate | 2025-02-01 |
| publisher | AIMS Press |
| record_format | Article |
| series | AIMS Mathematics |
| spelling | doaj-art-cf102f233f0a48f28feb055dd21155212025-08-20T01:54:41ZengAIMS PressAIMS Mathematics2473-69882025-02-011022958297310.3934/math.2025137Modeling default risk charge (DRC) with intensity probability theoryBadreddine Slime0Jaspreet Singh Sahni1Applied Mathematics University of Technology of Compiègne Alliance Sorbonne University, Compiègne, FranceMarket and Treasury Credit Risk, Emirates National Bank of Dubai, Dubai, UAEThe latest regulation [1] of the fundamental review of the trading book (FRTB) proposes replacing incremental risk charge (IRC) with default risk charge (DRC). Accordingly, many studies were implemented to analyze this change and its impact. Current modeling practices test several assumptions during conception and implementation. However, these assumptions impact model output and sometimes do not reflect market behavior. Two common assumptions used in DRC modeling in the literature are: (ⅰ) the default is implemented in a structural model (e.g., the Merton model) and (ⅱ) correlations between issuers follow the Gaussian copula. Notably, the Merton model does not pick up defaults for positions with a very small probability of default or instant default. Therefore, the structural approach results in a model risk that is not conservative enough to cover the DRC risk. In this paper, we compared an intensity model (CreditRisk+) to a structural model (Merton) to assess their impact on DRC and quantify the risk generated by the first assumption.https://www.aimspress.com/article/doi/10.3934/math.2025137credit riskmarket riskfundamental review of the trading book (frtb)default risk chargemodel riskmathematical finance modelingstatisticsprobability |
| spellingShingle | Badreddine Slime Jaspreet Singh Sahni Modeling default risk charge (DRC) with intensity probability theory AIMS Mathematics credit risk market risk fundamental review of the trading book (frtb) default risk charge model risk mathematical finance modeling statistics probability |
| title | Modeling default risk charge (DRC) with intensity probability theory |
| title_full | Modeling default risk charge (DRC) with intensity probability theory |
| title_fullStr | Modeling default risk charge (DRC) with intensity probability theory |
| title_full_unstemmed | Modeling default risk charge (DRC) with intensity probability theory |
| title_short | Modeling default risk charge (DRC) with intensity probability theory |
| title_sort | modeling default risk charge drc with intensity probability theory |
| topic | credit risk market risk fundamental review of the trading book (frtb) default risk charge model risk mathematical finance modeling statistics probability |
| url | https://www.aimspress.com/article/doi/10.3934/math.2025137 |
| work_keys_str_mv | AT badreddineslime modelingdefaultriskchargedrcwithintensityprobabilitytheory AT jaspreetsinghsahni modelingdefaultriskchargedrcwithintensityprobabilitytheory |