Direct Calibration of Maturity Adjustment Formula from Average Cumulative Issuer-Weighted Corporate Default Rates

by Dmitry Petrov of Lomonosov Moscow State University, and
Michael Pomazanov of State University - Higher School of Economics (Russia) & Bank Zenit

October 2008

Abstract: Of late years there is considerable progress in the development of credit risk models. Revised Framework on International Convergence of Capital Measurement and Capital Standards (2004) raised the standards of risk management on the new high level. At the same time the problem of theoretical investigation of probability of default time structure (and consequently maturity dependence of capital requirement, expected loss, etc.) rests actual. Basel Committee recommends to perform maturity adjustment in capital requirement. By its sense this adjustment is a penalty for exceeding one year maturity. However the direct procedure of receiving of proposed maturity adjustment rests undisclosed.

In this article the authors propose a method of calculation of maturity adjustment directly from open data. In addition analytical expressions revealing probability of default time structure are received. The character of our results is close enough to Basel proposal. However it was discovered that for low probabilities of default (high ratings) and maturities of 2-3 year there may exist underestimation of risk capital up to 50%.

JEL Classification: G32.

Keywords: Maturity adjustment, Capital Requirement, Basel II, Probability of default, PD time structure.

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