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If the probability of default parameters (PDs) fed as input into a creditportfolio model are estimated as through-the-cycle (TTC) PDs stressed marketconditions have little impact on the results of the capital calculationsconducted with the model. At first glance, this is totally different if the PDsare estimated as point-in-time (PIT) PDs. However, it can be argued that thereflection of stressed market conditions in input PDs should correspond to theuse of reduced correlation parameters or even the removal of correlations inthe model. Additionally, the confidence levels applied for the capitalcalculations might be made reflective of the changing market conditions. Weinvestigate the interplay of PIT PDs, correlations, and confidence levels in acredit portfolio model in more detail and analyse possible designs ofcapital-levelling policies. Our findings may of interest to banks that want tocombine their approaches to capital measurement and allocation with activeportfolio management that, by its nature, needs to be reflective of currentmarket conditions.

Capital allocation for credit portfolios under normal and stressed market conditions