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Modelling the distribution of credit losses with observable and latent factors

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  • Jiménez, Gabriel
  • Mencía, Javier
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    Abstract

    This paper proposes a dynamic model to estimate the credit loss distribution of the aggregate portfolio of loans granted in a banking system. We consider a sectoral approach distinguishing between corporates and households. The evolution of their default frequencies and the size of the loans portfolio are expressed as functions of macroeconomic conditions as well as unobservable credit risk factors, which capture contagion effects between sectors. In addition, we model the distributions of the Exposures at Default and the Losses Given Default. We apply our framework to the Spanish banking system, where we find that sectoral default frequencies are not only affected by economic cycles but also by a persistent latent factor. Finally, we identify the riskier sectors, perform stress tests and compare the relative risk of small and large institutions.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 16 (2009)
    Issue (Month): 2 (March)
    Pages: 235-253

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    Handle: RePEc:eee:empfin:v:16:y:2009:i:2:p:235-253

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Credit risk Probability of default Loss distribution Stress test Contagion Latent factors;

    References

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    1. Til Schuermann & Kevin J. Stiroh, 2006. "Visible and hidden risk factors for banks," Staff Reports 252, Federal Reserve Bank of New York.
    2. Fama, Eugene F., 1986. "Term premiums and default premiums in money markets," Journal of Financial Economics, Elsevier, vol. 17(1), pages 175-196, September.
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    4. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Risk Assessment for Banking Systems," Management Science, INFORMS, vol. 52(9), pages 1301-1314, September.
    5. Gabriel Jiménez & Jose A. Lopez & Jesus Saurina, 2009. "Empirical Analysis of Corporate Credit Lines," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5069-5098, December.
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    Cited by:
    1. Kauko, Karlo, 2010. "The feasibility of through-the-cycle ratings," Research Discussion Papers 14/2010, Bank of Finland.
    2. Pérez Montes, Carlos, 2014. "The effect on competition of banking sector consolidation following the financial crisis of 2008," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 124-136.
    3. Stefan Kerbl & Michael Sigmund, 2011. "What Drives Aggregate Credit Risk?," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 22.
    4. Carlos Pérez Montes, 2013. "Estimation of Regulatory Credit Risk Models," Banco de Espa�a Working Papers 1305, Banco de Espa�a.
    5. Lee, Yongwoong & Poon, Ser-Huang, 2014. "Forecasting and decomposition of portfolio credit risk using macroeconomic and frailty factors," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 69-92.

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