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Credit Risk Calculation The expected loss from the guarantor’s perspective is maximum lossprobability of default(1-recovery rate). The maximum loss is the difference between CMB value and MBS value. We use ratings transition to estimate the probability of default and assume that the recovery rate is zero. The Debt Specific Risk (DSR) and Incremental Risk Charge (IRC) system is used to capture credit spread risk, credit migration and default risk. We mainly focused on the present value (PV) evaluation and sensitivity calculation. Because the DSR and IRC pricing engine follows the same methodologies as Value at Risk (VaR), it inherits the weakness and risk uncertainties of the previous valuation models and risk sensitivity calculations in VAR. The exceptions are the single name CDS (and CDS index) and the convertible securities PV evaluations and sensitivity calculations. These have been vetted and approved in the Market Risk system and the Front Office system. Therefore, we mainly focussed on the implementation of the DSR and IRC pricing engine methodology. The vetting of the DSR and IRC pricing engine focussed on the valuation models for various debt products and derivatives, credit derivatives and hybrid instruments that are subject to credit spread risk, credit migration and default risk. The DSR and IRC pricing engine uses data from the same sources as VaR, including Bloomberg, Mark-it Partners, Summit, existing fixed income systems, and Imagine. In some cases, the existing VaR data was augmented with additional data from the source system. This additional data was obtained from existing data feeds that these sources produce for other Market Risk systems such as MASTERS and CCR. In addition, Market Risk conducted testing on this additional data to ensure its reasonability and completeness
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