Research On Credit Risk Of Contagion And Mitigation For Guaranty Portfolio In Commercial Bank

Credit risk is the most important risk in commercial banking industry. The key issues in credit risk management of commercial bank are default correlation, default contagion and default concentration of credit portfolio, which are the most popular and important research issues in credit risk modeling. Usually, commercial banks apply credit mitigation measures, such as guaranty, to reduce the correlation, contagion and concentration risk in credit portfolio management. Of all those measures, guaranty is the most frequently used one. When the underlying obligor (the guarantee) defaults, the guarantor has to take over the obligation responsibility, which can efficiently reduce losses for creditor while potentially increase the obligation of guarantor. Therefore, commercial banks should consider both the credit risk diversification effect and credit contagion effect incurred by guaranty. When the guaranty relation is activated, both mitigation and contagion would works in the portfolio, thus changing credit risk correlation, contagion and concentration risk complicatedly in the portfolio.This paper focuses on the portfolio mitigation and contagion effects incurred by guaranty relation, especially on the expected loss and unexpected loss in the portfolio. Based on the typical guaranty relations in commercial banks, this paper assumes the default state is absorbing, and contagion effect is lagged, as well as adopting the conditional independence assumption. This paper establish guaranty contagion model for default numbers with characterization of the transition probability matrix and default number distribution. 1 also extend the ASRF model to containing guaranty mitigation and contagion, while focusing on the detailed analysis of one-way guaranty relation, two-way guaranty relation and guaranty circle. The expected and unexpected losses are calculated in these three cases, as well as credit concentrations. In addition, empirical analysis shows that guaranty mitigation and contagion have significant effects on reserve and capital allocation. Therefore, this model has significant influence on the reserve and capital allocation for commercial banks.