Mathematical Finance Seminar

March 8, 2001 , 5:30 PM to 7:00 PM

Michel Crouhy, CIBC

Credit risk modeling for capital allocation

This presentation will briefly review two of the current proposed industry sponsored Credit Value-at-Risk methodologies and the practical issues relative to their implementation. First the credit migration approach, as proposed by JP Morgan with CreditMetrics, is based on the probability of moving from one credit quality to another, including default, within a given time horizon. Second, the option pricing, or structural approach, as initiated by KMV and which is based on the asset value model originally proposed by Merton (1974). In this model the default process is endogenous, and relates to the capital structure of the firm. Default occurs when the value of the firm's assets falls below some critical level. This presentation will also address some extensions of the credit migration framework to allow for the incorporation of credit derivatives and CLOs in a credit portfolio.