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Low Default Portfolios in Basel II and Basel III as a Special Case of Significantly Unbalanced Classes in Binary Choice Models

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  • Henry Penikas

    (Bank of Russia; National Research University Higher School of Economics; Lebedev Physical Institute of the Russian Academy of Sciences)

Abstract

In contemporary world, binary choice models are used in many areas. However, for all such areas, a problem arises when the share of one of the classes in the data sample is small. If this share is significantly small, this class is referred to as low default class. The purpose of this paper is to examine the definitions of such a portfolio and the approaches to building models on its basis. Although various methods exist for obtaining results, this paper shows that distinguishing a low default portfolio class, on the one hand, benefits banks, as does any more detailed segmentation, but, on the other hand, it deteriorates the statistical properties of the models for the probability of default. It is therefore justified that for the internal rating based approach in the framework of Basel II and Basel III the regulator should require that banks build their models based on combined data sets discouraging them from setting excessive low default portfolio classes.

Suggested Citation

  • Henry Penikas, 2020. "Low Default Portfolios in Basel II and Basel III as a Special Case of Significantly Unbalanced Classes in Binary Choice Models," Russian Journal of Money and Finance, Bank of Russia, vol. 79(2), pages 101-128, June.
    • Handle: RePEc:bkr:journl:v:79:y:2020:i:2:p:101-128
    DOI: 10.31477/rjmf.202002.101
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    Citations

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    Cited by:

    1. Henry Penikas, 2023. "Default correlation impact on the loan portfolio credit risk measurement for the "green" finance as an example," Bank of Russia Working Paper Series wps121, Bank of Russia.
    2. Henry Penikas, 2020. "IRB Asset and Default Correlation: Rationale for the Macroprudential Add-ons to the Risk-Weights," Bank of Russia Working Paper Series wps56, Bank of Russia.

    More about this item

    Keywords

    Basel II; IRB; low default portfolio; LDP; probability of default; unbalanced classes; binary choice (response) model;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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