Contents
CHAPTER 1
The Revolution in Credit—Capital Is the Key 1
The Credit Function Is Changing 1
Capital Is the Key 6
Economic Capital 8
Regulatory Capital 11
APPENDIX TO CHAPTER 1: A Credit Portfolio Model Inside
the IRB Risk Weights 21
Note 23
PART ONE
The Credit Portfolio Management Process 25
CHAPTER 2
Modern Portfolio Theory and Elements of the Portfolio 27
Modeling Process
Modern Portfolio Theory 27
Challenges in Applying Modern Portfolio Theory to
Portfolios of Credit Assets 34
Elements of the Credit Portfolio Modeling Process 38
Note 40
CHAPTER 3
Data Requirements and Sources for Credit
Portfolio Management 41
Probabilities of Default 41
Recovery and Utilization in the Event of Default 92
Correlation of Defaults 102
Notes 107
ix
CHAPTER 4
Credit Portfolio Models 109
Structural Models 110
Explicit Factor Models 133
Actuarial Models 141
Analytical Comparison of the Credit Portfolio Models 148
Empirical Comparison of the Credit Portfolio Models 153
What Models Are Financial Institutions Using? 161
Notes 161
APPENDIX TO CHAPTER 4: Technical Discussion of Moody’s–
KMV Portfolio Manager Mattia Filiaci 162
Default Correlation 162
Facility Valuation 163
Generating the Portfolio Value Distribution 174
Outputs 176
Notes 178
PART TWO
Tools to Manage a Portfolio of Credit Assets 181
CHAPTER 5
Loan Sales and Trading 183
Primary Syndication Market 183
Secondary Loan Market 191
Note 192
CHAPTER 6
Credit Derivatives with Gregory Hayt 193
Taxonomy of Credit Derivatives 193
The Credit Derivatives Market 201
Using Credit Derivatives to Manage a Portfolio of Credit Assets 203
Pricing Credit Derivatives 209
Notes 224
CHAPTER 7
Securitization 225
Elements of a CDO 225
“Traditional” and “Synthetic” CDO Structures 229
Applications of CDOs 233
x CONTENTS
To What Extent and Why Are Financial Institutions
Using Securitizations? 236
Regulatory Treatment 237
Note 240
PART THREE
Capital Attribution and Allocation 241
CHAPTER 8
Capital Attribution and Allocation 243
Measuring Total Economic Capital 243
Attributing Capital to Business Units 247
Attributing Capital to Transactions 252
Performance Measures—The Necessary Precondition
to Capital Allocation 258
Optimizing the Allocation of Capital 267
Notes 269
APPENDIX TO CHAPTER 8: Quantifying Operational Risk 270
Process Approaches 274
Factor Approaches 274
Actuarial Approaches 275
Notes 276
APPENDIX
Statistics for Credit Portfolio Management Mattia Filiaci 277
Basic Statistics 278
Applications of Basic Statistics 306
Important Probability Distributions 314
Notes 324
References 327
Index 333