An Early-warning and Dynamic Forecasting Framework of Default Probabilities for the Macroprudential Policy Indicators Arsenal
AbstractThe estimation of banks? marginal probabilities of default using structural credit risk models can be enriched incorporating macro-financial variables readily available to economic agents. By combining Delianedis and Geske?s model with a Generalized Dynamic Factor Model into a dynamic t-copula as a mechanism for obtaining banks? dependence, this paper develops a framework that generates an early warning indicator and robust out-of-sample forecasts of banks? probabilities of default. The database comprises both a set of Luxembourg banks and the European banking groups to which they belong. The main results of this study are, first, that the common component of the forward probability of banks? defaulting on their long-term debt, conditional on not defaulting on their short-term debt, contains a significant early warning feature of interest for an operational macroprudential framework driven by economic activity, credit and interbank activity. Second, incorporating the common and the idiosyncratic components of macro-financial variables improves the analytical features and the out-of-sample forecasting performance of the framework proposed.
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Bibliographic InfoPaper provided by Central Bank of Luxembourg in its series BCL working papers with number 75.
Length: 45 pages
Date of creation: Jul 2012
Date of revision:
Contact details of provider:
Web page: http://www.bcl.lu/
financial stability; macroprudential policy; credit risk; early warning indicators; default probability; Generalized Dynamic Factor Model; dynamic copulas; GARCH;
Find related papers by JEL classification:
- C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G1 - Financial Economics - - General Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-09 (All new papers)
- NEP-BAN-2012-09-09 (Banking)
- NEP-CBA-2012-09-09 (Central Banking)
- NEP-ECM-2012-09-09 (Econometrics)
- NEP-FOR-2012-09-09 (Forecasting)
- NEP-RMG-2012-09-09 (Risk Management)
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