The FSA has published Occasional Paper No. 29 entitled A multiple period Gaussian jump to default risk model.

The single-factor Gaussian copula method is a common approach for default risk modelling. However, the model deals with the distribution of default losses over a single period. Proposals currently under consideration for calculating a ‘jump to default’ risk capital charge for the trading book incorporate the concept of a liquidity horizon, which will be typically shorter than the capital horizon over which the jump to default risk charge has to be calculated. The liquidity horizon specifies a period over which a portfolio can be rebalanced. Depending on the rebalancing rules adopted (such as the constant level of risk assumption), an actively managed portfolio can exhibit a more benign default loss distribution relative to that of a constant portfolio over a given investment (or capital) horizon. The paper published by the FSA develops a general multi-period Gaussian copula model that incorporates the dynamics of default risk over time.

View A multiple period Gaussian jump to default risk model, (PDF 996KB), 13 August 2008