Chapter 16 - Integration of Credit and Market Risk

Abstract

This chapter discusses the problem of integrating credit and market risk within an economic capital framework. It analyzes two methods, one of which is based on a top-down concept. Loss distributions are separately obtained from market risk and credit risk approaches, and then integrated on top level. This can either be done in a factor model approach or more technically by the specification of the copula. The second approach tries to measure the entire risk integrated on a single-transaction level. The chapter considers all risk factors that might result in a change of value of a transaction. This second method is much more challenging and requires a new concept of risk measurement, that is, it is not possible to differentiate between market and credit risk anymore. Typical applications of this approach come up in the problem of volatile exposure in a credit portfolio model. Some new measures in this direction—such as potential future exposure measures—are also discussed in the chapter.