Maturity effect on low PD asset
- Thread starter laura1987
- Start date
Hi Laura,
If you have de Servigny, he illustrates in Figure 10-7
this refers to the un-intuitive inclusion of PD in the maturity adjustment under the credit IRB formula. See the last term in the formula:
http://forum.bionicturtle.com/viewreply/3722/
i.e., the maturity adjustment
M is fixed at 2.5 under foundation IRB, but under advanced IRB, the idea is: longer maturity increases this maturity (adjustment) multiplier
okay, that's the intuitive part!
but notice the PD: this has the effect of amplifying the maturity adjustment more so for lower PD (higher quality credits)...counterintuitive maybe
the basel rationale is basically "conservatism," along the lines of, a low PD credit, if we give it more time, has a greater chance of downgrade
(I prefer to think of as conservatism: low PDs have lower charge, but longer maturities should "dampen" the benefit)
David
If you have de Servigny, he illustrates in Figure 10-7
this refers to the un-intuitive inclusion of PD in the maturity adjustment under the credit IRB formula. See the last term in the formula:
http://forum.bionicturtle.com/viewreply/3722/
i.e., the maturity adjustment
M is fixed at 2.5 under foundation IRB, but under advanced IRB, the idea is: longer maturity increases this maturity (adjustment) multiplier
okay, that's the intuitive part!
but notice the PD: this has the effect of amplifying the maturity adjustment more so for lower PD (higher quality credits)...counterintuitive maybe
the basel rationale is basically "conservatism," along the lines of, a low PD credit, if we give it more time, has a greater chance of downgrade
(I prefer to think of as conservatism: low PDs have lower charge, but longer maturities should "dampen" the benefit)
David
...i was curious to recall the rationale for "dinging" low PDs...i don't see in the actual Accord but the *excellent* explanatory note on IRB risk weight gives the rationale (p.14)...again, this is merely the "why" of amplifying the maturity adjustment for low PDs (emphasis mine):
"Economically, maturity adjustments may also be explained as a consequence of mark-to-market (MtM) valuation of credits. Loans with high PDs have a lower market value today than loans with low PDs with the same face value, as investors take into account the Expected Loss, as well as different risk-adjusted discount factors. The maturity effect would relate to potential down-grades and loss of market value of loans. Maturity effects are stronger with low PDs than high PDs: intuition tells that low PD borrowers have, so to speak, more “potential” and more room for down-gradings than high PD borrowers. Consistent with these considerations, the Basel maturity adjustments are a function of both maturity and PD, and they are higher (in relative terms) for low PD than for high PD borrowers."
"Economically, maturity adjustments may also be explained as a consequence of mark-to-market (MtM) valuation of credits. Loans with high PDs have a lower market value today than loans with low PDs with the same face value, as investors take into account the Expected Loss, as well as different risk-adjusted discount factors. The maturity effect would relate to potential down-grades and loss of market value of loans. Maturity effects are stronger with low PDs than high PDs: intuition tells that low PD borrowers have, so to speak, more “potential” and more room for down-gradings than high PD borrowers. Consistent with these considerations, the Basel maturity adjustments are a function of both maturity and PD, and they are higher (in relative terms) for low PD than for high PD borrowers."
Similar threads
