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Concentration Risk in Credit Portfolios

Eva Lütkebohmert
Publication Date: 
Number of Pages: 
European Actuarial Academy Lecture Notes
[Reviewed by
Ita Cirovic Donev
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Concentration risk is one of the most important risk segments when measuring and presenting credit risk. Having inadequately measured concentration risk can lead to a substantial increase in costs for the financial institutions given the deterioration of the credit portfolio. Current Basel II regulation requires measurement of concentration risk. These lecture notes present one step further in academic literature on this topic.

These lecture notes consist of three parts: Introduction to Credit Risk Modeling, Concentration Risk in Credit Portfolios, and Default Contagion. All three sections are presented with detailed mathematical exposition and narrative explanation. Quite a lot of space is devoted to the introductory section, which results in a nice and thorough presentation of credit risk models. A novice to the credit risk measurement could understand this section with little side effort, as the author makes quite good balance between the motivation and theoretical presentation. Given the fact that this text belongs to a Lecture Notes series, this is quite a refreshing approach.

The second and main part of the book presents the analysis of concentration risk in credit portfolios. Again we are welcomed with an easy introduction to the subject. This is followed by a detailed discussion of name and sector concentration risk. Theoretical points are presented, in most cases, without proofs. This is mixed with discussion. As such it does not lack too much in substance for the first reading. Later one can add to the reading list from the references.

Examples are given throughout the section that relates to the German bank data. Results are presented via tables and several figures. The level of detail in examples follows the level of the theory presented.

The last section deals with default contagion or counterparty risk. This is very important concept especially in economies where the markets are narrower, i.e., in which more companies are dependent on each other in the market game. In such situations measuring concentration risk is of vital importance.

These lecture notes reflect current research and the international regulation of the banking sector. They can be of tremendous value to practitioners in financial institutions measuring and reporting concentration risk. It could also be of great value for graduate students in statistics, applied mathematics, and economics to see the technical side of the measures of concentration risk. However, for the real learning effect one would really need to apply this to a real credit portfolio to get a grasp on what is really going on.

Ita Cirovic Donev holds a Masters degree in statistics from Rice University. Her main research areas are in mathematical finance; more precisely, statistical methods for credit and market risk. Apart from the academic work she does statistical consulting work for financial institutions in the area of risk management.