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Empirical Estimation of Default and Asset Correlation of Large Corporates and Banks in India

by Arindam Bandyopadhyay of National Institute of Bank Management (NIBM), Pune, India, and
Sonali Ganguly of National Institute of Bank Management (NIBM), Pune, India

August 2011

Abstract: Estimation of default and asset correlation is crucial for banks to manage and measure portfolio credit risk. This would require studying the risk profile of the banks' entire credit portfolio and developing the appropriate methodology for the estimation of default dependence. Measurement and management of correlation risk in the credit portfolio of banks has also become an important area of concern for bank regulators worldwide. The BCBS (2006) has specifically included an asset correlation factor in the computation of credit risk capital requirement by banks adopting the Internal Ratings Based Approach. We estimate default correlation in the credit portfolio of banks. These correlation estimates will help the regulator in India to understand the linkage between bank's portfolio default risks with the systematic factors. We also derive default and asset correlations of Indian corporate and compare it with global scenario. The work tries to find the relationship of the correlation to the default probability as specified by the Basel committee. The findings of this paper could be used further in estimating portfolio credit risk, economic capital and risk adjusted returns on economic capital for large corporate exposures of banks.

JEL Classification: G21, G35, C15.

Keywords: Default Correlation, Asset Correlation, Credit .

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