A Study of the Regulatory Input Parameters in the Granularity Adjustment of the Gordy-Lütkebohmert Model and a New Method to Calibrate Them to Rating Grades

18 Pages Posted: 1 Mar 2019

See all articles by Dr. Achim Posthaus

Dr. Achim Posthaus

Frankfurt School of Finance and Management

Date Written: February 19, 2019

Abstract

The Gordy-Lütkebohmert model marks the golden standard for determining the granularity adjustment in regulatory capital assessments. The granularity adjustment is necessary for an approximation of the effect of undiversified idiosyncratic risk in not infinite fine grained portfolios. Internal ratings-based (IRB) risk weights of Basel II and III assume that idiosyncratic risk is diversified away on portfolio level, therefore implicitly assuming that the number of individual exposures in the portfolio trends towards ∞.

The Gordy-Lütkebohmert model is used in practise by many regulatory driven approaches as it develops a parsimonious, analytical traceable and easy to implement formula for determining the granularity adjustment. It requires certain input parameters, which are:
a) dependent from underlying exposures of the portfolio (bank inputs)
b) and a set of external (regulatory) parameters.

This paper examines the regulatory input parameters and describes a new parsimonious method to calibrate and map them to rating grades.

Keywords: Gordy-Lütkebohmert Model, Granularity Adjustment, Regulatory Capital Assessment, IRB Risk Weights, Model Calibration, Portfolio Credit Risk

JEL Classification: C36, G28

Suggested Citation

Posthaus, Achim, A Study of the Regulatory Input Parameters in the Granularity Adjustment of the Gordy-Lütkebohmert Model and a New Method to Calibrate Them to Rating Grades (February 19, 2019). Available at SSRN: https://ssrn.com/abstract=3338113 or http://dx.doi.org/10.2139/ssrn.3338113

Achim Posthaus (Contact Author)

Frankfurt School of Finance and Management

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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