VaR and expected shortfall in portfolios of dependent credit risks: Conceptual and practical insights

Rüdiger Frey, Alexander McNeil

Publication: Scientific journalJournal articlepeer-review


In the first part of this paper we address the non-coherence of value-at-risk (VaR) as a risk measure in the context of portfolio credit risk, and highlight some problems which follow from this theoretical deficiency. In particular, a realistic demonstration of the non-subadditivity of VaR is given and the possibly nonsensical consequences of VaR-based portfolio optimisation are shown. The second part of the paper discusses VaR and expected shortfall estimation for large balanced credit portfolios. All standard industry models (Creditmetrics, KMV, CreditRisk+) are presented as Bernoulli mixture models to facilitate their direct comparison. For homogeneous groups it is shown that measures of tail risk for the loss distribution may be approximated in large portfolios by analysing the tail of the mixture distribution in the Bernoulli representation. An example is given showing that, for portfolios of lower quality, choice of model has some impact on measures of extreme risk.
Article Outline
Original languageEnglish
Pages (from-to)1317 - 1334
JournalJournal of Banking and Finance
Publication statusPublished - 1 May 2002

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