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Double Impact: Credit Risk Assessment and Collateral Value

by Ali Chabaane of ACA Consulting & BNP Paribas,
Jean-Paul Laurent of the University of Lyon & BNP Paribas, and
Julien Salomon of BNP Paribas

February 2004

Abstract: This paper deals with credit portfolio risk analysis. The benchmark Basel II IRB approach relies on the independence between losses given defaults and default events. Nevertheless, empirical evidence shows that recovered values are likely to be lower when the number of defaults increases, such as in recession periods. We consider a model embedding Basel II that allows to deal with dependence between recovery rates and default events. We then study loss distributions for large credit portfolios. We show that both expected credit losses and standard risk measures such as credit VaR or Expected Shortfall tend to increase compared with the Basel II approach.

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