IMPACT OF CREDIT SPREAD FLUCTUATIONS ON PORTFOLIO VALUE

Banks criticize Basel accords for potential double counting of the same risks in calculation methods of minimum required capital. These risks should be isolated from each other for accurate measurement of regulatory capital. The purpose of this paper is to isolate credit spread risk from interest rate risk and analyze the impact of pure credit spread fluctuations on portfolio value. Different scenarios are simulated by using Monte Carlo simulation method. The model is built in Excel and Visual Basic for Applications. The results show that coupon rates and credit spread deviations have an impact on the average and the standard deviation of portfolio value which makes them among the majors factors in assigning bond weights. Besides, the interest rate component that reduces the fluctuations in standard deviation should also be taken into consideration in assigning the weights.