Abstract: In the context of bank economic capital management, the economic capital of a municipality, defined as its revenue available for debt servicing and salable asset, covers its debt and can be used as a guideline to set debt limit. Utilizing the CreditMetrics Model enhanced by copula function, this paper presents an empirical analysis to determine the debt limit for municipal bond issuance, with a sample of 18 unmatured intermediate-term municipal bonds issued by the city of Hefei. We first derives discount rates of forward zero curves with 5-year government bond yields in the inter-dealer market adjusted by credit risk premiums. Then along with the credit quality transition matrix provided by domestic rating firms, the paper calculates VaR’s for individual bonds. With MonteCarlo simulation and correlation matrix estimated with copula functions, we arrive at the portfolio VaR. Comparing the VaR with economic capital will help to determine Hefei’s debt limit.

Key words: local bonds, Credit Metrics model, VaR, issue limit