Concentration Risk Under the Default Risk Charge (DRC)

In the last regulation for the minimum capital market risk requirements, Fundamental Review of the Trading Book (FRTB), one of the major changes is replacing the Incremental Risk Charge (IRC) with the Default Risk Charge (DRC). The DRC measures only the default and it does not take account of the migration rating risk. The second new change in this approach is that the DRC also includes the equity assets, contrary to the IRC. In this paper, we study the DRC modeling under the Internal Model Approach (IMA) and the regulator conditions that every DRC components must respect. The FRTB presents the DRC measurement as a Value at Risk (VaR), over a one-year horizon, with the quantile equal to 99.9%. We use the multi-factor adjustment to measure the DRC, and we compare it with the Monte Carlo Model to view the fitting of this approach. We then define the concentration in the DRC, and we propose two approaches to quantifying the concentration risk: Ad-hoc and Add-on method. We finally study the behavior of the DRC with respect to the concentration risk