A Unified Model Of CrediteMetris And Stress Test

Banks and financial institutions in many countries are developing and enhancing methods to measure and manage the main risk inherent in their business operation : the credit risk of their loan portfolios. The famous methods is CreditMetrics model.The CreditMetrics model entails the same basic procedure as the measurement of market risk, i.e.the VAR framework.While VaR models have proven themselves to be very useful rise management tools, recent financial debacles have also highlighted their limitations—in particular, their excessive dependency on history or unrealistic statistical assumptions. The CreditMetrics model has also this limitation. The natural response to these limitations is for firms to resort to stress tests to complement the results of their VaR analyse. Stress tests are exercises to determine the losses that might occur under unlikely but plausible circumstances, and there has been a dramatic increase in the importance given to stress testing since the east Asian crisis and the LTCM affair. However, traditional stress testing is done on a stand-alone basis, and the results of stress tests are evaluated side-by-side with the results of traditional market risk (or VaR) models. This creats problems for risk managers, who then have to choose which set of risk exposures to"believe". Now we suggests a solution to this problem by integrating stress testing into CreditMetrics model by assigning probabilities to stress-test scenarios. The new model is the combination of CreditMetrics and stress test , in which the scenarios become a direct input into the risk model, instead of being generated internally. The different participants can be fully aware of the scenarios being used in the VAR calculation and the probability assigned to each of them. We write up the simulation process of new model and compare the result from new model with from CreditMetrics model.