Compliance by default

Capital requirements for market risk are set to change dramatically under proposed new rules to capture incremental default risk. Alan Smillie and Eduardo Epperlein take a look at the rules as they stand, suggest an alternative way forward and discuss some of the key technical challenges in modelling default risk in the trading book

Until 2005, it seemed that market risk would be relatively unaffected by the introduction of Basel II, in contrast to the sweeping changes to the rules for credit and operational risk. The first indication of material changes to the market trading risk regime was given by regulators in their consultative document of April 2005 and in their final amendment to Basel II, issued in July 2005 (Basel Committee on Banking Supervision, 2005a). The July 2005 document required banks to explicitly model

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