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Stress testing of probability of default of individuals

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  • Petr Kadeřábek
  • Aleš Slabý
  • Josef Vodička
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    Abstract

    This paper introduces a model for stress testing of probability of default of individuals. The model rests on assumption that the individual defaults if his savings fall below zero. The probability of default is then described as a function of several macroeconomic indicators, such as wages, unemployment and interest rates. Stress testing is carried out by applying exogenous stress scenarios for development of these indicators. The model implies that sensitivity of probability of default to the stress is mainly driven by installment to income ratio and for mortgages also by loan maturity. Hence installment to income ratio is suggested as the appropriate tool to manage credit risk of retail portfolios.

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    Bibliographic Info

    Article provided by University of Economics, Prague in its journal Prague Economic Papers.

    Volume (Year): 2008 (2008)
    Issue (Month): 4 ()
    Pages: 340-355

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    Handle: RePEc:prg:jnlpep:v:2008:y:2008:i:4:id:336:p:340-355

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    Related research

    Keywords: stress testing; probability of default; credit risk; banking;

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    References

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    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    2. John Whitley & Richard Windram & Prudence Cox, 2004. "An empirical model of household arrears," Bank of England working papers 214, Bank of England.
    3. Andrew B. Abel, 1991. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
    4. David B. Gross & Nicholas S. Souleles, 1999. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Center for Financial Institutions Working Papers 98-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
    5. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
    6. Petr JAKUBÍK, 2007. "Macroeconomic Environment and Credit Risk (in English)," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(1-2), pages 60-78, March.
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