Consider two defaultable 1-year loans with a principal of $1 million each. The probability of default...

 

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Consider two defaultable 1-year loans with a principal of $1 million each. The probability of default on each loan is 2.5%. Assume that if one loan defaults, the other does not. Assume that in the event of default, the loan leads to a loss that can take any value between $0 and $1 million with equal probability, i.e., the probability that the loss is higher than $x million is 1-x. If a loan does not default, it yields a profit equal to $20,000. a) Compute the 1-year 98% Value at Risk (VaR) and Expected Shortfall (ES) of a single loan. b) Compute the 1-year 98% VaR and ES for the portfolio of both loans. c) Does the VaR and the ES satisfy the subadditivity property in this case? Consider two defaultable 1-year loans with a principal of $1 million each. The probability of default on each loan is 2.5%. Assume that if one loan defaults, the other does not. Assume that in the event of default, the loan leads to a loss that can take any value between $0 and $1 million with equal probability, i.e., the probability that the loss is higher than $x million is 1-x. If a loan does not default, it yields a profit equal to $20,000. a) Compute the 1-year 98% Value at Risk (VaR) and Expected Shortfall (ES) of a single loan. b) Compute the 1-year 98% VaR and ES for the portfolio of both loans. c) Does the VaR and the ES satisfy the subadditivity property in this case?

Answer rating: 100% (QA)

a The 1year 98 Value at Risk VaR is 02 Million and the Expect... View the full answer