Title

A capital adequacy buffer model

Document Type

Journal Article

Publisher

Routledge

Place of Publication

United Kingdom

School

School of Business and Law

RAS ID

20126

Comments

Originally published as: Allen, D. E., McAleer, M., Powell, R. J., & Singh, A. K. (2016). A capital adequacy buffer model. Applied Economics Model, 23(3), 175-179. Original article available here

Abstract

We develop a new capital adequacy buffer model (CABM) that is sensitive to dynamic economic circumstances. The model, which measures additional back capital required to compensate for fluctuating credit risk, is a novel combination of the Merton structural model, which measures distance to default and the timeless capital asset pricing model (CAPM), which measures additional returns to compensate for additional share price risk. We apply the model to a portfolio of mid-cap loan assets over a 10-year period that includes pre-GFC (global financial crisis), GFC and post-GFC. An analysis of actual defaults over this period shows the model to be far more accurate in determining the capital adequacy levels needed to counter credit risk that an unresponsive ratings model such as the Basel standardized approach.

DOI

10.1080/13504851.2015.1061639

Access Rights

Not open access

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