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Simulation Based Approach for Measuring Concentration Risk

by Joocheol Kim of Yonsei University, and
Duyeol Lee of Yonsei University

April 2007

Abstract: Asymptotic Single Risk Factor (ASRF) model is used to derive the regulatory capital formula of Internal Ratings-Based approach in the new Basel accord(Basel II). One of the important assumptions in ASRF model for credit risk is that the given portfolio is well diversified so that one can easily calculate the required capital level by focusing only on systematic risk. In real world, however, idiosyncratic risk of a portfolio cannot be fully diversified away, causing the so called concentration risk problem. In this paper we suggest simulation based approach for measuring concentration risk using bank capital dynamic model. This approach is especially suitable for a portfolio with relatively small to medium number of obligors and relatively large sized loans.

JEL Classification: G32, G33, G38.

Keywords: Basel II, ASRF model, credit risk, concentration risk.

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