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Dr. Andrew Barnes : Risk Measurement and Capital Allocation for large loan portfolios



Calculation of portfolio loss distributions is an important part of credit risk management in all large banking institutions. Mathematically, this calculation is tantamount to efficiently computing the probability distribution of the sum of a very large number of correlated random variables. Typical Monte Carlo aggregation models apply brute force computation to this problem and suffer from two main drawbacks: lack of speed and lack of transparency for further credit risk analysis. I will describe an attempt to ameliorate these drawbacks via an asymptotic probabilistic method based on the Central Limit Theorem. I will next describe capital allocation, a process of attributing risk to individual transactions or subportfolios of a given portfolio. In so doing, I will state axioms for coherent risk measures. These axioms place the notion of risk measurement and diversification on a firm mathematical foundation. I will then describe axioms for capital allocation via coherent risk measures, and illustrate the ideas with efficient computational formulae for allocating capital based on a couple of commonly used risk measures. In the course of this talk, which will be geared towards graduate students, I will attempt to give a flavor of industrial research and role of applied mathematics in industry.

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