8 research outputs found
Transition Probability Matrix Methodology for Incremental Risk Charge
As part of Basel II's incremental risk charge (IRC) methodology, this paper summarizes our extensive investigations of constructing transition probability matrices (TPMs) for unsecuritized credit products in the trading book. The objective is to create monthly or quarterly TPMs with predefined sectors and ratings that are consistent with the bank's Basel PDs. Constructing a TPM is not a unique process. We highlight various aspects of three types of uncertainties embedded in different construction methods: 1) the available historical data and the bank's rating philosophy; 2) the merger of one-year Basel PD and the chosen Moody's TPMs; and 3) deriving a monthly or quarterly TPM when the generator matrix does not exist. Given the fact that TPMs and specifically their PDs are the most important parameters in IRC, it is our view that banks may need to make discretionary choices regarding their methodology, with uncertainties well understood and managed.Basel II, trading book, incremental risk charge, default probability, default correlation, transition probability matrix, generator matrix, credit portfolio
Transition Probability Matrix Methodology for Incremental Risk Charge
As part of Basel II's incremental risk charge (IRC) methodology, this paper
summarizes our extensive investigations of constructing transition probability
matrices (TPMs) for unsecuritized credit products in the trading book. The
objective is to create monthly or quarterly TPMs with predefined sectors and
ratings that are consistent with the bank's Basel PDs. Constructing a TPM is
not a unique process. We highlight various aspects of three types of
uncertainties embedded in different construction methods: 1) the available
historical data and the bank's rating philosophy; 2) the merger of one-year
Basel PD and the chosen Moody's TPMs; and 3) deriving a monthly or quarterly
TPM when the generator matrix does not exist. Given the fact that TPMs and
specifically their PDs are the most important parameters in IRC, it is our view
that banks may need to make discretionary choices regarding their methodology,
with uncertainties well understood and managed
Transition Probability Matrix Methodology for Incremental Risk Charge
As part of Basel II's incremental risk charge (IRC) methodology, this paper summarizes our extensive investigations of constructing transition probability matrices (TPMs) for unsecuritized credit products in the trading book. The objective is to create monthly or quarterly TPMs with predefined sectors and ratings that are consistent with the bank's Basel PDs. Constructing a TPM is not a unique process. We highlight various aspects of three types of uncertainties embedded in different construction methods: 1) the available historical data and the bank's rating philosophy; 2) the merger of one-year Basel PD and the chosen Moody's TPMs; and 3) deriving a monthly or quarterly TPM when the generator matrix does not exist. Given the fact that TPMs and specifically their PDs are the most important parameters in IRC, it is our view that banks may need to make discretionary choices regarding their methodology, with uncertainties well understood and managed.