Journal of Credit Risk

Risk.net

An asset drop model as an alternative to the treatment of double defaults within the Basel framework

Sebastian Ebert and Eva Lütkebohmert

ABSTRACT

In 2005 the internal-ratings-based (IRB) approach of Basel II was enhanced by a "treatment of double default effects" to account for credit risk mitigation techniques such as ordinary guarantees or credit derivatives. This paper reveals several caveats to this approach, and presents a new method of accounting for double default effects. This new asset drop technique can be applied within any structural model of portfolio credit risk. When formulated within the IRB approach, data requirements are moderate and economic capital can still be computed analytically.

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