Calibration of the Simplified Supervisory Formula Approach

Full paper available here.

The Simplified Supervisory Formula Approach (SSFA) is a simple, ad hoc approach to allocating capital across tranches with different seniorities. The SSFA has been adopted by the Basel authorities in their latest proposal (December 2013) as their formula-based approach for securitisation regulatory capital with a given calibration.

In this paper, we present an alternative way to calibrate the SSFA that is more straightforward and transparent. This calibration is based on the rigorous, analytically solvable Arbitrage Free Approach (AFA) elaborated by Duponcheele et al. (2013a,b,c,d). In order to perform this calibration, we build upon the detailed investigation we have conducted on appropriate asset class-specific parameters for the Conservative Monotone Approach (CMA, a variant of the AFA). The CMA and its calibration are described in a sister paper, Duponcheele et al. (2014b).

Our calibration has broader significance than simply the parameter values we obtain, in that we show how, by calibrating the SSFA for different regulatory asset classes, one may differentiate capital (across different parts of the securitisation market in a risk sensitive manner) without placing unrealistic information demands on investors.

Last, we demonstrate how to achieve a much better fit between the capital charges implied by the SSFA and those implied by a more rigorous, model-based analysis such as the CMA. This can be done through a simple modification of the SSFA, by adding one additional parameter driving the 1250% risk weight threshold.