Creditmetrics

CreditMetrics™ – Technical Document
The benchmark for understanding credit risk
New York April 2, 1997

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A value-at-risk (VaR) framework applicable to all institutions worldwide that carry credit risk in the course of their business. A full portfolio view addressing credit event correlations which can identify the costs of over concentration and benefits of diversification in amark-to-market framework. Results that drive: investment decisions, risk-mitigating actions, consistent risk-based credit limits, and rational risk-based capital allocations.

J.P. Morgan
Co-sponsors: Bank of America Bank of Montreal BZW Deutsche Morgan Grenfell KMV Corporation Swiss Bank Corporation Union Bank of Switzerland

This Technical Document describes CreditMetrics™, a framework forquantifying credit risk in portfolios of traditional credit products (loans, commitments to lend, financial letters of credit), fixed income instruments, and market-driven instruments subject to counterparty default (swaps, forwards, etc.). This is the first edition of what we intend will be an ongoing refinement of credit risk methodologies. Just as we have done with RiskMetrics™, we are making ourmethodology and data available for three reasons: 1. 2. We are interested in promoting greater transparency of credit risk. Transparency is the key to effective management. Our aim is to establish a benchmark for credit risk measurement. The absence of a com mon point of reference for credit risk makes it difficult to compare different approaches to and measures of credit risk. Risks are comparableonly when they are measured with the same yardstick. We intend to provide our clients with sound advice, including advice on managing their credit risk. We describe the CreditMetrics™ methodology as an aid to clients in under standing and evaluating that advice.

3.

Both J.P. Morgan and our co-sponsors are committed to further the development of CreditMetrics™ as a fully transparent set ofrisk measurement methods. This broad sponsorship should be interpreted as a signal of our joint commitment to an open and evolving standard for credit risk measurement. We invite the participation of all parties in this continuing enterprise and look forward to receiving feedback to enhance CreditMetrics™ as a benchmark for measuring credit risk. CreditMetrics™ is based on, but differs significantlyfrom, the risk measurement methodology developed by J.P. Morgan for the measurement, management, and control of credit risk in its trading, arbitrage, and investment account activities. We remind our readers that no amount of sophisticated analytics will replace experience and professional judgment in managing risks. CreditMetrics™ is nothing more than a high-quality tool for the professional riskmanager in the financial markets and is not a guarantee of specific results.

CreditMetrics™—Technical Document Copyright © 1997 J.P. Morgan & Co. Incorporated. All rights reserved. CreditMetrics™ is a trademark of J.P. Morgan in the United States and in other countries. It is written with the symbol ™ at its first occurance in the publication, and as CreditMetrics thereafter.

CreditMetrics™— Technical Document

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This book
Authors:
Greg M. Gupton Morgan Guaranty Trust Company Risk Management Research (1-212) 648-8062 gupton_greg@jpmorgan.com Christopher C. Finger Morgan Guaranty Trust Company Risk Management Research (1-212) 648-4657 finger_christopher@jpmorgan.com Mickey Bhatia Morgan Guaranty Trust Company Risk Management Research (1-212) 648-4299bhatia_mickey@jpmorgan.com

This is the reference document for CreditMetrics™. It is meant to serve as an introduction to the methodology and mathematics behind statistical credit risk estimation, as well as a detailed documentation of the analytics that generate the data set we provide. This document reviews: • the conceptual framework of our methodologies for estimating credit risk; • the description of the...