How Market and Credit Loss Distributions Differ

Summary

The document contrasts market-risk portfolio outcomes with credit-risk losses. Market risk is commonly described through profit and loss because market positions can produce gains as well as losses. Its distribution may be roughly normal in shape, but the response notes that it can have fat tails, skew, and a sharper peak than a normal distribution. Its mean is often near zero, though it may be positive or negative.

For credit risk, the response points to the Vasicek distribution as a commonly used model for portfolio credit losses and describes its tail as very long. It does not provide a graph or a detailed derivation, and it does not resolve the question about whether discounted credit losses can be negative. The comparison is therefore a qualitative guide to typical distributional features, not a rule that fits every portfolio or horizon.

Key ideas

• Market portfolios can generate profits, so market outcomes are usually described as profit and loss.
• Market profit-and-loss distributions may depart from normality through fat tails, skew, and a tall peak.
• Market profit-and-loss means are often near zero but can be positive or negative.
• The Vasicek distribution is cited as a common model for portfolio credit losses with a long tail.
• The response does not settle whether discounted credit losses can fall below zero.

Tags

# Market vs. Credit Loss distributions: differences


# Market vs. Credit Loss distributions: differences












If we define the Loss distribution of a portfolio as

$$L_{t+h}=-(V_{t+h}-V_{t})$$

where $V_{t}$ is the value of the portfolio at time $t$ and $h$ is the time horizon, which are the (graphical) differences between a Loss distribution regarding Market Risk and a one regarding Credit Risk?

For example, could a Market Loss distribution of a bank portfolio have an expected loss different from zero?

Can't the Credit Loss distribution go below zero because you can't earn more than what you lent, if the cash flow is discounted?

## Answer by Magic is in the chain (score 1, accepted)

https://quant.stackexchange.com/a/50407

For an example of the portfolio credit loss distribution, please check the Vasicek distribution, which is frequently used for modelling the credit portfolio losses. It shows a a very long tail - an example below:

In market risk, one talks about Profit and Loss (as opposed to just loss because market portfolios do make profit from time to time!). The distribution will be close to normal (compared to normal it has fat tails, skew, tall peaks etc), mean usually close to zero but can be positive or negative.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.