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Importance Sampling for Integrated Market and Credit Portfolio Models

by Peter Grundke of the University of Cologne

April 2009

Abstract: A sophisticated approach for computing the total economic capital needed for various stochastically dependent risk types is the bottom-up approach. In this approach, usually, market and credit risks of financial instruments are modeled simultaneously. As integrating market risk factors into standard credit portfolio models increases the computational burden of calculating risk measures, it is analyzed to which extent importance sampling techniques previously developed either for pure market portfolio models or for pure credit portfolio models can be successfully applied to integrated market and credit portfolio models. Specific problems which arise in this context are discussed. The effectiveness of these techniques is tested by numerical experiments for linear and non-linear portfolios.

JEL Classification: C63, G21, G33.

Keywords: Bottom-up approach, Credit risk, Importance sampling, Interest rate risk, Risk management, Value-at-risk.

Published in: European Journal of Operational Research, Vol. 194, No. 1, (April 2009), pp. 206-226.

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