Capital allocation in credit portfolios in a multiperiod setting: a literature review and practical guidelines

This article reviews the literature on techniques of credit risk models, multi-period risk measurement, and capital allocation, and gives a tutorial on applying these techniques to credit portfolios with a focus on practical aspects. The effects of the choice of considered loss process concerning the handling of write-offs and matured assets or rating migration are displayed, and the impact on portfolio optimization decisions is discussed. We point out the trade-off between short-term and long-term profitability and allude to the practical challenges of an application of multi-period risk measurement.