Journal of Risk

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Systematic credit cycle risk of financial collaterals: modeling and evidence

Marc Gürtler*, Dirk Heithecker

ABSTRACT

In the new capital adequacy framework adopted by the Basel Committee in June 2004 (Basel II), the eligibility of collaterals, especially financial collaterals, was extended compared to the rules that had applied previously. However, financial assets are valued conservatively in the credit context, which suggests that there is a strong correlation between collaterals and credit default rates. This paper discusses the impact of the dependence of financial collaterals and default rates on credit risk. A general calculation framework for the loss rate of collateralized loans is given and an analytical solution for the valuation of financial collaterals is presented. The model we derive is applied to empirical data for German insolvencies and German capital markets.  

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