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Modeling Cycle Dependence in Credit Insurance

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  • Anisa Caja

    ()
    (Université Claude Bernard Lyon 1, ISFA, 69007, France)

  • Frédéric Planchet

    ()
    (Université Claude Bernard Lyon 1, ISFA, 69007, France)

Abstract

Business and credit cycles have an impact on credit insurance, as they do on other businesses. Nevertheless, in credit insurance, the impact of the systemic risk is even more important and can lead to major losses during a crisis. Because of this, the insurer surveils and manages policies almost continuously. The management actions it takes limit the consequences of a downturning cycle. However, the traditional modeling of economic capital does not take into account this important feature of credit insurance. This paper proposes a model aiming to estimate future losses of a credit insurance portfolio, while taking into account the insurer’s management actions. The model considers the capacity of the credit insurer to take on less risk in the case of a cycle downturn, but also the inverse, in the case of a cycle upturn; so, losses are predicted with a more dynamic perspective. According to our results, the economic capital is over-estimated when not considering the management actions of the insurer.

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Bibliographic Info

Article provided by MDPI, Open Access Journal in its journal Risks.

Volume (Year): 2 (2014)
Issue (Month): 1 (March)
Pages: 74-88

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Handle: RePEc:gam:jrisks:v:2:y:2014:i:1:p:74-88:d:34057

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Related research

Keywords: credit insurance; cycles; regime-switching Markov chain; rating transition matrix; multi-factor Merton model; economic capital;

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  1. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
  2. Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.).
  3. Christensen, Jens H.E. & Hansen, Ernst & Lando, David, 2004. "Confidence sets for continuous-time rating transition probabilities," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2575-2602, November.
  4. Siem Jan Koopman & Andr� Lucas, 2003. "Business and Default Cycles for Credit Risk," Tinbergen Institute Discussion Papers 03-062/2, Tinbergen Institute, revised 09 Jan 2003.
  5. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  6. Koopman, Siem Jan & Kräussl, Roman & Lucas, André & Monteiro, André B., 2009. "Credit cycles and macro fundamentals," Journal of Empirical Finance, Elsevier, vol. 16(1), pages 42-54, January.
  7. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
  8. Bangia, Anil & Diebold, Francis X. & Kronimus, Andre & Schagen, Christian & Schuermann, Til, 2002. "Ratings migration and the business cycle, with application to credit portfolio stress testing," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 445-474, March.
  9. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
  10. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
  11. Lando, David & Skodeberg, Torben M., 2002. "Analyzing rating transitions and rating drift with continuous observations," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 423-444, March.
  12. Jafry, Yusuf & Schuermann, Til, 2004. "Measurement, estimation and comparison of credit migration matrices," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2603-2639, November.
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