In this paper I develop a framework to think through the interpretation an important piece of the new Basel guidelines for setting trading book capital. This piece – the Incremental Risk Charge (IRC) – is intended to cover default and migration risks in the trading book. Any bank that...

This issue of the Journal focuses on risk management for longer-term portfolios. The first article, by Eugene Stern, deals with a classic problem that individual investors face, but that is also important to institutional asset managers: how can one tell if a portfolio is poorly diversified?...

In the first paper, Christopher Finger presents empirical tests on variations of the standard model for tranched credit derivatives, or synthetic CDOs. There is a rich literature of new model proposals or extensions, but little empirical work focusing on the typical application of the model....

In this article, we discuss the standard pricing model framework for synthetic CDOs. Though the standard framework is by now well accepted, how the model is implemented precisely and, importantly, how the model is applied, vary across the marketplace. We discuss some of the outstanding...

For single horizon models of defaults in a portfolio, the effect of model and distribution choice on the model results is well understood. Collateralized Debt Obligations in particular have sparked interest in default models over multiple horizons. For these, however, there has been little...

In counterparty credit risk management for swaps, forwards, and other derivative contracts, it is recognized that most common applications of credit exposure measures suffer from the deficiency of assuming that counterparty default is independent of the amount exposed. Stress tests are often...

We examine the performance of the standard tranched credit derivative (or synthetic CDO) pricing model over most of the lifetime of these derivatives. As the market for these derivatives is quite liquid, we focus on the application of the model for hedging, rather than for absolute pricing. We...