Calculating Concentration-Sensitive Capital Charges with Conditional Value-at-Risk

TL;DR

This paper develops a semi-asymptotic approach using Conditional Value-at-Risk (CVaR) to better account for concentration risks in credit portfolios, comparing it with Basel Committee proposals within a Vasicek model.

Contribution

It introduces a new semi-asymptotic method for calculating concentration-sensitive capital charges using CVaR, enhancing existing Basel risk weight formulas.

Findings

The CVaR-based approach detects concentrations effectively.

Comparison shows differences between proposed and Basel capital charges.

The method is applicable within the Vasicek one-factor model.

Abstract

By mid 2004, the Basel Committee on Banking Supervision (BCBS) is epected to launch its final recommendations on minimum capital requirements in the banking industry. Although there is the intention to arrive at capital charges which concur with economic intuition, the risk weight formulas proposed by the committee will lack an adequate treatment of concentration risks in credit portfolios. The question arises whether this problem can be solved without recourse to fully-fledged portfolio models. Since recent practical experience shows that the risk measure Conditional Value-at-Risk (CVaR) is particularly well suited for detecting concentrations, we develop the semi-asymptotic approach by Emmer and Tasche in the CVaR context and compare it with the capital charges recently suggested by the Basel Committee. Both approaches are based on the same Vasicek one-factor model.