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Rule-Based LTV and Penalty Function for Concentration Risk
Year Of Publication: 2012
Month Of Publication: February
Pages: 60
Download Count: 2
View Count: 1186
Comment Num: 0
Language: English
Source: working paper
Who Can Read: Free
Date: 3-1-2012
Publisher: Administrator
Summary
This paper implements a simple and transparent procedure for setting loan-to-value (LTV) ratio based on the market risk of the underlying collateralized portfolio. The loan hair cut (i.e. 1-LTV) is closely related to value-at-risk (VaR) which is very sensitive to model assumptions and complicated to estimate in the non-Gaussian multi-variate case. Our calculation first employs a Rule-Based LTV based on the sum of the individuals VaRs, which in turns is individually calibrated to historical volatility-VaR relationship. Next, in order to correct for the concentration-diversication effect of the portfolio, we propose a variance adjusted concentration measure which generalizes the Herndahl-Hirschman index by weights reflecting the variance of the individual assets. Furthermore, to adjust for the correlation relationship, we adopt a multi-factor framework where the correlations are driven by the regional and industry sectors. The combined adjustment factor is derived in closed form. In the empirical tests, we collect 10-day returns of the most frequently pledged stocks from 1998 and 2010 and group them into 10 regions and 10 industries
Author(s)
Poon, Ser-Huang Sign in to follow this author
Zhang, Yiran Sign in to follow this author
Lee, Yongwoong Sign in to follow this author
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