Basel II rules allow qualified banks to assess the risk in their portfolio of credit exposures with a methodology based on the informational content of credit ratings and two crucial assumptions: (1) the credit risk of individual exposures is driven by one systematic risk factor only and (2) the...

Traditionally, regulation of banks has focused on the riskentailed in bank loans. Loans are typically nontradedassets. In recent years, another component of bank assetshas become increasingly important: assets actively tradedin the financial markets.1 These assets form the “tradingbook” of a...