The recent incremental risk charge addition to the Basel (1996) market risk amend-
ment requires banks to estimate, separately, the default and migration risk of their
trading portfolios that are exposed to credit risk. The new regulation requires the total
regulatory charges for trading books to be computed as the sum of the market risk capi-
tal and the incremental risk charge for credit risk. In contrast to Basel II models for the
banking book no model is prescribed and banks can use internal models for calculating
the incremental risk charge. In the calculation of incremental risk charges a key compo-
nent is the choice of the liquidity horizon for traded credits. In this paper we explore the
e¤ect of the liquidity horizon on the incremental risk charge. Speci�cally we consider a
sample of 28 bonds with di¤erent rating and liquidity horizons to evaluate the impact
of the choice of the liquidity horizon for a certain rating class of credits. We �find that
choosing the liquidity horizon for a particular credit there are two important effects that
needs to be considered. Firstly, for bonds with short liquidity horizons there is a miti-
gation effect of preventing the bond from further downgrades by trading it frequently.
Secondly, there is the possibility of multiple defaults. Of these two effects the multiple
default effect will generally be more pronounced for non investment grade credits as the
probability of default is severe even for short liquidity periods. For medium investment
grade credits these two effects will in general o¤set and the incremental risk charge will
be approximately the same across liquidity horizons. For high quality investment grade
credits the effect of the multiple defaults is low for short liquidity horizons as the frequent
trading effectively prevents severe downgrades