Dynamic Factor analysis of industry sector default rates and implication for Portfolio Credit Risk Modelling
AbstractIn this paper we use a reduced form model for the analysis of Portfolio Credit Risk. For this purpose, we fit a Dynamic Factor model, DF, to a large dataset of default rates proxies and macrovariables for Italy. Multi step ahead density and probability forecasts are obtained by employing both the direct and indirect method of prediction together with stochastic simulation of the DF model. We, first, find that the direct method is the best performer regarding the out of sample projection of financial distressful events. In a second stage of the analysis, we find that reduced form Portfolio Credit Risk measures obtained through DF are lower than the one corresponding to the Internal Ratings Based analytic formula suggested by Basel 2. Moreover, the direct method of forecasting gives the smallest Portfolio Credit Risk measures. Finally, when using the indirect method of forecasting, the simulation results suggest that an increase in the number of dynamic factors (for a given number of principal components) increases Portfolio Credit Risk.
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Bibliographic InfoPaper provided by University of Modena and Reggio E., Dept. of Economics in its series Center for Economic Research (RECent) with number 007.
Length: pages 28
Date of creation: Oct 2007
Date of revision:
Dynamic Factor Model; Forecasting; Stochastic Simulation; Risk Management; Banking;
Other versions of this item:
- Cipollini, Andrea & Missaglia, Giuseppe, 2007. "Dynamic Factor analysis of industry sector default rates and implication for Portfolio Credit Risk Modelling," MPRA Paper 3582, University Library of Munich, Germany.
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
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