I am trying to calculate the Total Credit Risk capital % for my learning purpose as given below. Assuming adding 1 single loan with different pds.
i have noticed one point in the table and have two queries.
Point 1: As PD increasing, the highly risky bands gets lower credit risk capital %.
Question1: Is there any rational behind this?, why we need to keep lower capital for risky bands?
Question2: The calculated credit risk capital % contains both EL+UL or just UL. I mean credit VAR(EL+UL) or Just Unexpected loss capital?. Is there any correction required?
a. I am creating the bands from 1 to 10, band 1 is least risky and band 10 is highly risky. I am computing the odds by considering the odds for band 1 is .10 and doubling the odds for rest of the bands.
b. Computing the Logodds and PD for each band. formula for Logodds is ln(odds) and EXP(logodds)/(1+EXP(logodds)) in excel.
c. PD Variance and LGD Variance using variance formula ie eg for PD --- PD*(1-PD).
d. EL% is PD*LGD.
e. Unexpected Loss -Single loan "First square the Loss Given Default and multiply it with the Probability of Default Variance. Next multiply the Probability of Default with the Loss Given Default Variance. Add these two values together and take its square root.This new percentage is the standard deviation.
f. Portfolio Correlation Factor is 5.36%.
g. Multiply this correlation Factor with the newly calculated Unexpected Loss(single loan) and the result is the Unexpected Loss Contribution.
h. To get the credit risk capital % -- Multiplying the Unexpected Loss Contribution with the Unexpected Loss Capital Multiplier( say 6) for 99.97% confidence.