Credit Value at Risk under Basel III – Too Simplistic?

Gunter Meissner

“Bank supervisors play an important role in encouraging the proper balance of risk-taking by developing prudent standards and enforcing sound practices at banks”

– Alan Greenspan

In this chapter, we will discuss the counterparty-credit-risk approach of the Basel II accord, which was envisioned to be part of Basel III. We will see that the approach applies the one-factor Gaussian copula (OFGC) model, which we analysed in Chapter 7. To clarify, credit value-at-risk (CVaR) is a concept that quantifies correlated counterparty credit risk in standard portfolios with bonds and loans. In Chapters 15 and 16, we will discuss Basel III’s approach of credit value adjustment (CVA). CVA also quantifies correlated counterparty credit risk, however, in derivatives portfolios. While CVaR is derived by the value-at-risk (VaR) concept, Basel III applies the expected shortfall (ES) concept to calculate CVA.

First, let us look at some basics.

WHAT ARE THE BASEL I, II AND III ACCORDS? WHY DO MOST SOVEREIGNS IMPLEMENT THE ACCORDS?

We briefly introduced the Basel accords in Chapter 1. We will expand the discussion in this chapter, especially the correlation aspects of the accords.

The

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