Skip to main content
Article thumbnail
Location of Repository

Monte Carlo Simulation in the Integrated Market and Credit Portfolio Model

By Selly Kane, Viktoria Krupp and Jack Macki


Credit granting institutions deal with large portfolios of assets. These assets represent credit granted to obligors as well as investments in securities. A common size for such a portfolio lies from anywhere between 400 to 10,000 instruments. The essential goal of the credit institution is to minimize their losses due to default. By default we mean any event causing an asset to stop producing income. This can be the closure of a stock as well as the inability of an obligor to pay their debt, or even an obligor's decision to pay out all his debt. Minimizing the combined losses of a credit portfolio is not a deterministic problem with one clean solution. The large number of factors influencing each obligor, different market sectors, their interactions and trends, etc. are more commonly dealt with in terms of statistical measures. Such include the expectation of return and the volatility of each asset associated with a given time horizon. In this sense, we consider in the following the expected loss and risk associated with the assets in a credit portfolio over a given time horizon of (typically) 10 to 30 years. We use a Monte Carlo approach to simulate the loss of a portfolio in multiple scenarios, which leads to a distribution function for the expected loss of the portfolio over that time horizon. Second, we compare the results of the simulation to a Gaussian approximation obtained via the Lindeberg-Feller Theorem. Consistent with our expectations, the Gaussian approximation compares well with a Monte Carlo simulation in case of a portfolio of very risky assets. Using a model which produces a distribution of expected losses allows credit institutions to estimate their maximum expected loss with a certain confidence interval. This in turn helps in taking important decisions about whether to grant credit to an obligor, to exercise options or otherwise take advantage of sophisticated securities to minimize losses. Ultimately, this leads to the process of credit risk management

Topics: Finance
Year: 2001
OAI identifier:

Suggested articles


  1. (1999). An analytical approach for credit risk analysis under correlated defaults, Credit Metrics Monitor,
  2. (1974). On the pricing of corporate debt: the risk structure of interest rates,
  3. (1997). Portfolio credit risk I, doi
  4. (1997). Portfolio credit risk II, doi

To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.