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Portfolio Credit Risk and Macroeconomic Shocks

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  • Miguel A. Segoviano Basurto
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    Abstract

    Portfolio credit risk measurement is greatly affected by data constraints, especially when focusing on loans given to unlisted firms. Standard methodologies adopt convenient, but not necessarily properly specified parametric distributions or simply ignore the effects of macroeconomic shocks on credit risk. Aiming to improve the measurement of portfolio credit risk, we propose the joint implementation of two new methodologies, namely the conditional probability of default (CoPoD) methodology and the consistent information multivariate density optimizing (CIMDO) methodology. CoPoD incorporates the effects of macroeconomic shocks into credit risk, recovering robust estimators when only short time series of loans exist. CIMDO recovers portfolio multivariate distributions (on which portfolio credit risk measurement relies) with improved specifications, when only partial information about borrowers is available. Implementation is straightforward and can be very useful in stress testing exercises (STEs), as illustrated by the STE carried out within the Danish Financial Sector Assessment Program.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/283.

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    Length: 50
    Date of creation: 01 Dec 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/283

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    Keywords: Stress testing; Economic conditions; Statistics; Economic models; credit risk; probability; equation; probabilities; time series; financial statistics; multivariate distribution; multivariate distributions; optimization; calibration; risk modeling; applications; risk-weighted assets; random variables; probability distribution; financial systems; equations; risk management; emerging markets; risk model; correlation; random variable; predictions; mathematical models; integral; parameter vector; banking crises; standard errors; probability distributions; correlations; normal distribution; probability density; risk assessment; normal distributions; mean square; samples; mathematics; goodness of fit; statistical inferences; banking systems; frequency distribution; simulation process; cumulative distribution function; mathematical statistics; stochastic processes; statistic; calculus; maximum likelihood estimation; survey; linear model; mathematical theory; central limit theorem; market risk; number of parameters; capital requirements; empirical measure; statistical methods; calculus of variations; risk managers; housing finance; finite sample; moral hazard; statistical terms; accounting standards;

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    1. Philip Lowe, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," FMG Discussion Papers dp428, Financial Markets Group.
    2. Miguel Angel Segoviano & Philip Lowe, 2002. "Internal ratings, the business cycle, and capital requirements: some evidence from an emerging market economy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston.
    3. Berger, Allen N. & Udell, Gregory F., 1990. "Collateral, loan quality and bank risk," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 21-42, January.
    4. Eichengreen, Barry & Arteta, Carlos, 2000. "Banking Crises in Emerging Markets: Presumptions and Evidence," Center for International and Development Economics Research, Working Paper Series qt3pk9t1h2, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
    5. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    6. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-72, January.
    7. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
    8. Philip Lowe & Miguel A. Segoviano, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," BIS Working Papers 117, Bank for International Settlements.
    9. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
    10. Asli Demirgüç-Kunt & Enrica Detragiache, 1997. "The Determinants of Banking Crises," IMF Working Papers 97/106, International Monetary Fund.
    11. Reinhart, Carmen & Tokatlidis, Ioannis, 2005. "Before and After Financial Liberalization," MPRA Paper 6986, University Library of Munich, Germany.
    12. Miguel Segoviano, 2006. "Consistent Information Multivariate Density Optimizing Methodology," FMG Discussion Papers dp557, Financial Markets Group.
    13. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany.
    14. Martin Cihák, 2006. "How Do Central Banks Writeon Financial Stability?," IMF Working Papers 06/163, International Monetary Fund.
    15. Burkhard Drees & Ceyla Pazarbasioglu, 1995. "The Nordic Banking Crises," IMF Working Papers 95/61, International Monetary Fund.
    16. Claudio E. V. Borio & Wilhelm Fritz, 1995. "The response of short-term bank lending rates to policy rates: a cross-country perspective," BIS Working Papers 27, Bank for International Settlements.
    17. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    18. Charles Goodhart & Miguel A. Segoviano, 2004. "Basel and procyclicality: a comparison of the standardised and IRB approaches to an improved credit risk method," LSE Research Online Documents on Economics 24821, London School of Economics and Political Science, LSE Library.
    19. Franklin Allen & Douglas Gale, 1998. "Bubbles and Crises The Economic Journal," Center for Financial Institutions Working Papers 98-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
    20. Miguel A. Segoviano & Philip Lowe, 2002. "Internal ratings, the business cycle and capital requirements: some evidence from an emerging market economy," LSE Research Online Documents on Economics 24948, London School of Economics and Political Science, LSE Library.
    21. Charles Goodhart & Boris Hofmann & Miguel Segoviano, 2004. "Bank Regulation and Macroeconomic Fluctuations," Oxford Review of Economic Policy, Oxford University Press, vol. 20(4), pages 591-615, Winter.
    22. Philip Lowe & Claudio Borio, 2002. "Asset prices, financial and monetary stability: exploring the nexus," BIS Working Papers 114, Bank for International Settlements.
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