Modeling Credit Risk

In this chapter we present some simple approaches to measure credit risk. We start in Section 2.1 with a short overview of the standardized approach of the Basel framework for banking supervision. This approach is a representative of the so-called notional-amount approach. In this concept, the risk of a portfolio is defined as the sum of the notional values of the individual securities in the portfolio, where each notional value may be weighted by a certain risk factor, representing the riskiness of the asset class to which the security belongs. The advantage of this approach is its apparent simplicity, however, it has several drawbacks as, for example, netting and diversification effects are not taken into account.