Content area
Full Text
Credit Risk: Pricing, Measurement, and Management, by Darrell Duffie and Kenneth J. Singleton, 2003, Princeton, NJ: Princeton University Press
Credit risk is the major challenge for risk managers and market regulators. International regulation of banks' credit risk was put in place in 1988 and since that time there has been no consensus on how to improve that regulatory framework. Part of the explanation resides in the complexity of this risk. Banks, regulators, and central banks do not agree on how to measure credit risk and, more particularly, on how to compute the optimal capital that is necessary for protecting the different partners that share this risk. For example, what proportion of yield spreads on corporate bonds is explained by credit risk? Is it 30 percent, 50 percent, or even 90 percent? Is the credit risk proportion of the observed spreads solely a function of variations in the default probability or is it also explained by variations in the recovery rate over time or across cycles? Are macroeconomic cycles themselves or default risk premia, market liquidity, and even market risk significant determinants of yield spreads? These questions are important because some models such as CreditMetrics use the entire yield spread to compute the capital for credit risk. If credit risk explains only a small fraction of yield spreads, these models compute too much capital for regulation and even for credit risk management (Dionne et al., 2004 and references therein).
Asking banks to keep too much capital in reserve to cover credit risk can be a source of market distortion in risk management behavior (Allen and Gale, 2003; Dionne and Harchaoui, 2003). For example, it may generate some asset substitution activities that increase the risky position of banks, in order to set the level of risk at its optimal rather than regulatory level. All these issues arise in part because credit risk is not well understood. So the book by Duffie and Singleton will be welcomed by the academics, regulators, and practitioners who consult it.
The book has 13 chapters, three appendices (two on affine processes), a comprehensive list of references, and an index (authors and subjects). It covers all subjects related to credit risk. It is designed for three broad audiences: academics and graduate students;...