Credit Value at Risk

Overview

Credit VAR is a Value at Risk model that factors in only credit risk.

As is the case with most portfolios, one of the critical factor to consider is the correlations between the assets in the portfolio, in this case, correlations among the defaults of the assets. There is essentially two ways to model credit portfolio risk.

• Portfolio from Individual Assets - Once the individual assets have been modeled, it is time to aggregate the results into a portfolio. For a credit portfolio, the portfolio cant be modeled as the sum of the results of each asset. This is due to the fact that the defaults and loss size for individual assets are often correlated, and this must be included explicitly in the model.
• Portfolio (Collective Model) - constructs a model of the number of portfolio defaults by modeling the portfolio as a whole, rather than as a sum of assets.

VAR Measurment

VAR measurement entails specifying a probability, computing the distribution of losses, and then specifying the losses at the point in the distribution specified by the chosen probability. For most credit models of a certain degree of complexity, the easiest way to compute this number is to simulate the losses, sort them by size, and then find the loss at the point specified by the chosen probability.