Journal of Credit Risk
ISSN:
1744-6619 (print)
1755-9723 (online)
Editor-in-chief: Linda Allen and Jens Hilscher
Need to know
- We develop a model that describes how the presence of a primary firm affects the loss distribution of a portfolio of loans to secondary firms.
- Many credit card holders have either direct or indirect exposure to primary firms. We derive the loss distribution for large portfolios of credit cards.
- We show that failure to account for the presence of a primary firm can result in the value-at-risk and the expected shortfall being under estimated.
Abstract
Many financial institutions provide loans to secondary firms, whose economic survival depends on the economic condition of primary firms. Even if loans from primary firms are not held in the loan portfolio, the financial distress of primary firms can adversely affect the loan portfolio of a financial institution. This paper describes a simple model that can be used for risk management. Our model directly incorporates the dependence of the conditional probability of default and loss given default of secondary firms on primary firms. Two simple examples show that failure to account for such dependence can result in the value-at-risk and the expected shortfall being greatly underestimated.
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