Osadchiy, Maksim (2021): Vasicek Model Extension. Premature default.
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Abstract
The IRB approach underlies Basel II and Basel III. The approach is based on the Vasicek distribution. The main advantage of the distribution is simplicity and accounting for default correlation. But the distribution substantially underestimates probability of default due to ignoring of premature defaults. Besides, the IRB approach uses the maturity adjustment, which is a kind of a black box, since there is no clear information about the econometric model and calibration of its parameters. If maturity exceeds one year, the IRB formula leads to negativity and even discontinuity of capital in the neighborhood of zero default probability. The paper suggests the Vasicek-Black-Cox (VBC) model, which is constructed to fix drawbacks of the IRB approach. The VBC model is constructed on the base of the Vasicek model and the Black-Cox model. The Vasicek model is a special case of the VBC model, designed to evaluate the default distribution taking into account premature defaults. The VBC model was constructed using the Method of Images, since the firm in the framework of the Black-Cox model is treated as the barrier binary option.
Item Type: | MPRA Paper |
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Original Title: | Vasicek Model Extension. Premature default |
English Title: | Vasicek Model Extension. Premature default |
Language: | English |
Keywords: | IRB; Vasicek; Merton; Black-Cox; barrier options; default distribution |
Subjects: | G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation |
Item ID: | 108687 |
Depositing User: | Maksim Osadchiy |
Date Deposited: | 09 Jul 2021 12:23 |
Last Modified: | 09 Jul 2021 12:23 |
References: | BIS (2005), An Explanatory Note on the Basel II IRB Risk Weight Functions, July 2005 Black F, Cox JC. (1976), Valuing corporate securities: some effects of bond indenture provisions. J. Finance 31:351–67 Kupiec, P. H. (2009), How Well Does the Vasicek-Basel Airb Model Fit the Data? Evidence from a Long Time Series of Corporate Credit Rating Data, FDIC Working Paper Series Merton, R.C., (1974), On the pricing of corporate debt: the risk structure of interest rates. J. Finance, 29:449–70 Vasicek O., (1987), Probability of Loss on Loan Portfolio, KMV Corporation Vasicek O., (2002), The Distribution of Loan Portfolio Value, Risk, December, 160-162 |
URI: | https://mpra.ub.uni-muenchen.de/id/eprint/108687 |