| Pub. Date | : Sep, 2022 |
|---|---|
| Product Name | : The IUP Journal of Financial Risk Management |
| Product Type | : Article |
| Product Code | : IJFRM020922 |
| Author Name | :Yogesh Malhotra |
| Availability | : YES |
| Subject/Domain | : Finance Management |
| Download Format | : PDF Format |
| No. of Pages | : 13 |
Financial institutions face many risks which increase the degree of uncertainty about future net returns. Credit risk can result in potential losses for a company and is a function of the credit exposure, the probability of default and the loss in the event of default. For a given credit instrument portfolio of credit obligations such as a portfolio of corporate bonds or swaps, Credit Value-at-Risk (VaR) quantifies how much at most can be lost with a given probability over a specific time horizon. The associated CreditMetrics Methodology, originally introduced in 1997 by JP Morgan, is now considered the industry standard along with Credit VaR for credit risk modeling. The CreditMetrics methodology is used for assessing portfolio risk due to changes in bond or debt value caused by credit quality changes, including credit migration (upgrades and downgrades) as well as default. It measures the uncertainty in forward value of the bond portfolio at the risk horizon caused by such credit events. CreditMetrics offers better understanding of credit risk in terms of diversification benefits and concentration risk compared to standard capital adequacy measures. This paper provides a framework for using this methodology.
Financial institutions are subject to many sources of risk, where risk often represents the degree of uncertainty about future net returns. Such key risks are often distinguished in terms of credit risk, liquidity risk, market risk and operational risk (Malhotra, 2015). Credit risk can result in potential loss due to the inability of a counterparty to meet its obligations and is a function of the credit exposure, the probability of default and the loss in the event of default. Liquidity risk results from need of some specific liquidity for a specific asset, wherein the firm may be compelled to sell highly illiquid assets at a discount. Market risk denoting the uncertainty of future earnings is a function of the changes in market conditions. Operational risk results from errors in settling payments or transactions, including the risk of fraud and regulatory risks. From a financial perspective, often such risks are computed in terms of Value-at-Risk, also known as VaR. Originally invented by JP Morgan, VaR has introduced quantitative rigor to fathom multidimensional complexity of risk with a simple and