Credit Risk: Pricing, Measurement, And Management (Book Review‪)‬

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).