Benchmarking Asset Correlations

Among the most crucial input parameters for credit portfolio risk models are the co-movements ofdefault risks. Due to limited empirical evidence about the magnitude of correlations the New BaselCapital Accord sets standard requirements for calculating regulatory capital requirements, e.g. in theConsultative Document as of April 2003 asset correlations for sovereigns, banks and corporates between12% and 24% depending on default probabilities are assumed. The present contribution showshow correlations can be estimated within the framework of the Basel II model. Using default datafrom the G7 countries it is shown that asset correlations are much lower than broadly assumed. Thismay have valuable consequences for backtesting of PD...