The small b in the IRB approach

[ahnnecabiles]

Hi David,

In the formula K = LGD X f(PD) X f(M,b)

You mentioned in your Basel Primer that the small b in the maturity adjustment f(M,b) incorporates both maturity and probability of default. Does it mean that, aside from the impact on asset's PD as incorporated in the f(PD), there is also an impact of the asset's PD in the maturity? Could you please expound on this?

Thanks so much.

 

[ahnnecabiles]

Just a follow-through, what is the Basel's rationale for giving higher maturity adjustments to assets with lower pd (higher quality exposures)? Thanks!

 

[ahnnecabiles]

Hi David,

No need to answer this question (sorry for rocking your boat). I already got the answer from your blog entitled "IRB credit risk function explained." Very nice explanation, I got difficulty in understanding the Basel reading on IRB function, but your blog clearly explains it all. Thanks!

 

[David Harper CFA FRM]

Hi Chinquee,

Great, I almost forgot about this post:
http://www.bionicturtle.com/learn/article/basel_ii_internal_ratings_based_irb_credit_risk_function/

Another way to think of this is that Basel conservatively assumes narrow spreads (i.e., high quality credits) tend to widen over time. (This is why Stulz' Credit Spread formula should be removed; it contradicts the rest of the cirriculm on spreads versus maturity)

Thanks, David