Asset correlation, portfolio diversification and regulatory capital in the Basel Capital Accord

Article


Gottschalk, S. 2011. Asset correlation, portfolio diversification and regulatory capital in the Basel Capital Accord. Risk Governance and Control: Financial Markets & Institutions. 1 (3). https://doi.org/10.22495/rgcv1i3art3
TypeArticle
TitleAsset correlation, portfolio diversification and regulatory capital in the Basel Capital Accord
AuthorsGottschalk, S.
Abstract

In this paper, we analyze the properties of the KMV model of credit portfolio loss. This theoretical model constitutes the cornerstone of Basel II’s Internal Ratings Based(IRB) approach to regulatory capital. Our results show that this model tends to overestimate the probability of portfolio loss when the probability of default of a single firm and the firms’ asset correlations are low. On the contrary, probabilities of portfolio loss are underestimated when the probability of default of a single firm and asset correlations are high. Moreover, the relationship between asset correlation and probability of
loan portfolio loss is only consistent at very high quantiles of the portfolio loss distribution. These are precisely those adopted by the Basel II Capital Accord for the calculations of capital adequacy provisions. So, although the counterintuitive properties of the KMV model do not extend to Basel II, they do restrict its generality as a model of credit portfolio loss.

KeywordsAssets; Basel Accord; Regulatory Capital
Sustainable Development Goals9 Industry, innovation and infrastructure
Middlesex University ThemeCreativity, Culture & Enterprise
PublisherVirtus Interpress
JournalRisk Governance and Control: Financial Markets & Institutions
ISSN2077-429X
Electronic2077-4303
Publication dates
Online2011
PrintJul 2011
Publication process dates
Accepted01 Jul 2011
Deposited21 Mar 2025
Output statusPublished
Publisher's version
File Access Level
Restricted
Digital Object Identifier (DOI)https://doi.org/10.22495/rgcv1i3art3
Permalink -

https://repository.mdx.ac.uk/item/qxq64

  • 6
    total views
  • 1
    total downloads
  • 0
    views this month
  • 0
    downloads this month

Export as

Related outputs

Green financing for shipping industry: results of a marine professionals’ survey
Bace, E., Singh, S. and Gottschalk, S. 2025. Green financing for shipping industry: results of a marine professionals’ survey. Journal of Environmental and Earth Sciences. 7 (3), pp. 306-315. https://doi.org/10.30564/jees.v7i3.7733
Are English SMEs disadvantaged in accessing Green Finance? A study of UK (bank and non-bank) debt finance provision
Gottschalk, S., Owen, R. and Coban, I. 2024. Are English SMEs disadvantaged in accessing Green Finance? A study of UK (bank and non-bank) debt finance provision. Centre for the Understanding of Sustainable Prosperity (CUSP).
Demand for external finance by environmentally-motivated SMEs: An exploration of geographical disparities and potential in relation to Net Zero
Gottschalk, S. and Owen, R. 2023. Demand for external finance by environmentally-motivated SMEs: An exploration of geographical disparities and potential in relation to Net Zero. London, UK Enterprise Research Centre (ERC).
International financial regulation of cryptoassets and asset-backed tokens
Gottschalk, S. 2023. International financial regulation of cryptoassets and asset-backed tokens. in: Kim, S. (ed.) Fintech, Pandemic, and the Financial System: Challenges and Opportunities Leeds, UK Emerald. pp. 145-181
Institutional and geopolitical aspects of bond spreads impacts on corporate capital structure in emerging markets
Gottschalk, S. and Ndang, B. 2023. Institutional and geopolitical aspects of bond spreads impacts on corporate capital structure in emerging markets. Global Business & Economics Review. 28 (3), pp. 266-297. https://doi.org/10.1504/GBER.2023.129996
Social Enterprise: Market Trends 2019
Owen, R., Lyon, F., Vickers, I. and Gottschalk, S. 2021. Social Enterprise: Market Trends 2019. London DCMS.
Digital currency price formation: a production cost perspective
Gottschalk, S. 2022. Digital currency price formation: a production cost perspective. Quantitative Finance and Economics. 6 (4), pp. 669-695. https://doi.org/10.3934/QFE.2022030
The impact of the financial crisis on the Euro area
Holland, D., Barrell, R., Fic, T., Gottschalk, S., Hurst, I., Liadze, I. and Orazgani, A. 2008. The impact of the financial crisis on the Euro area. National Institute Economic Review. 206, pp. 90-100. https://doi.org/10.1177/0027950108099854
From Black Wednesday to Brexit: Macroeconomic shocks and correlations of equity returns in France, Germany, Italy, Spain, and the United Kingdom
Gottschalk, S. 2021. From Black Wednesday to Brexit: Macroeconomic shocks and correlations of equity returns in France, Germany, Italy, Spain, and the United Kingdom. International Journal of Finance & Economics. 28 (3), pp. 2843-2873. https://doi.org/10.1002/ijfe.2567
Product quality and the international location of manufacturing industry
Gottschalk, S. 2002. Product quality and the international location of manufacturing industry. Journal of economic integration. 17 (2), pp. 363-376. https://doi.org/10.11130/jei.2002.17.2.363
Can market size outweigh adverse comparative advantage?
Gottschalk, S. 2002. Can market size outweigh adverse comparative advantage? The Journal of International Trade & Economic Development. 11 (1), pp. 43-61. https://doi.org/10.1080/09638190110093154
The impact of executive board gender diversity on risk-taking in Canadian and US banks
Gottschalk, S. 2019. The impact of executive board gender diversity on risk-taking in Canadian and US banks. SSRN. https://doi.org/10.2139/ssrn.3485543
A closed-form formula for pricing bonds between coupon payments
Gottschalk, S. 2018. A closed-form formula for pricing bonds between coupon payments.
A closed-form formula for pricing bonds between coupon payments
Gottschalk, S. 2018. A closed-form formula for pricing bonds between coupon payments. Mathematical Finance Letters. 2018, pp. 1-16. https://doi.org/10.28919/mfl/3650
Entropy measure of credit risk in highly correlated markets
Gottschalk, S. 2017. Entropy measure of credit risk in highly correlated markets. Physica A: Statistical Mechanics and its Applications. 478, pp. 11-19. https://doi.org/10.1016/j.physa.2017.02.083
Capital adequacy requirements in emerging markets
Barrell, R. and Gottschalk, S. 2010. Capital adequacy requirements in emerging markets. in: Gottschalk, R. (ed.) The Basel Capital Accords in developing countries: Challenges for development finance London, UK. Palgrave Macmillan. pp. 97-140
The impact of EMU on growth and employment
European Commission, Directorate General Economic and Financial Affairs, Barrell, R., Gottschalk, S., Holland, D., Khoman, E., Liazde, I. and Pomerantz, O. 2008. The impact of EMU on growth and employment. Brussels ,Belgium European Commission. https://doi.org/10.2765/63598
Foreign direct investment and exchange rate uncertainty in South‐East Asia
Gottschalk, S. and Hall, S. 2008. Foreign direct investment and exchange rate uncertainty in South‐East Asia. International Journal of Finance & Economics. 13 (4), pp. 349-359. https://doi.org/10.1002/ijfe.355
Fiscal policy in Europe
Barrell, R. and Gottschalk, S. 2007. Fiscal policy in Europe. National Institute Economic Review. 201 (1), pp. 33-36. https://doi.org/10.1177/0027950107083047
Macroeconomic policy in Europe: Experiments with monetary responses and fiscal impulses
Barrell, R., Becker, B., Byrne, J., Gottschalk, S., Hurst, I. and van Welsum, D. 2004. Macroeconomic policy in Europe: Experiments with monetary responses and fiscal impulses. Economic Modelling. 21 (5), pp. 877-931. https://doi.org/10.1016/j.econmod.2003.10.005
The volatility of the output gap in the G7
Barrell, R. and Gottschalk, S. 2004. The volatility of the output gap in the G7. National Institute Economic Review. 188, pp. 100-107. https://doi.org/10.1177/00279501041881008
Wage moderation policy in Germany
Barrell, R., Becker, B. and Gottschalk, S. 2003. Wage moderation policy in Germany. NIESR.