Credit Risk

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Summary

The objective of this paper is to compare two approaches to modelling Credit-Value-at-Risk: CreditMetrics and CreditRisk+. This is important for regulators and for risk managers who are concerned with allocating capital efficiently. The few studies already available on this subject focus narrowly on the risk of default. This paper incorporates both the risk of default and the risk which arises from changes in credit ratings (migration risk). 

The paper builds on the work done by Koyluoglu and Hickman(1998), but we make a significant extension by assessing the impact of migration risk on credit- risk. We make very careful comparison of Credit-Value-at-Risk for the two models using Monte Carlo techniques on standardised portfolios of bonds. 

The conclusion is that for regulators, the model which is used matters very little. This is because regulators are concerned with extreme values and loss distributions of both models capture information only about defaults at very high confidence levels. However, for internal purposes, where rating migrations matter more than default, CreditMetrics can generate higher estimates of risk.

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