Measuring bank capital requirements through Dynamic Factor analysis
AbstractIn this paper, using industry sector stock returns as proxies of firm asset values, we obtain bank capital requirements (through the cycle). This is achieved by Montecarlo simulation of a bank loan portfolio loss density. We depart from the Basel 2 analytical formula developed by Gordy (2003) for the computation of the economic capital by, first, allowing dynamic heterogeneity in the factor loadings, and, also, by accounting for stochastic dependent recoveries. Dynamic heterogeneity in the factor loadings is introduced by using dynamic forecast of a Dynamic Factor model fitted to a large dataset of macroeconomic credit drivers. The empirical findings show that there is a decrease in the degree of Portfolio Credit Risk, once we move from the Basel 2 analytic formula to the Dynamic Factor model specification.
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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 010.
Length: pages 26
Date of creation: Feb 2008
Date of revision:
Dynamic Factor Model; Forecasting; Stochastic Simulation; Risk Management; Banking;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-10-07 (All new papers)
- NEP-BAN-2008-10-07 (Banking)
- NEP-BEC-2008-10-07 (Business Economics)
- NEP-CFN-2008-10-07 (Corporate Finance)
- NEP-FOR-2008-10-07 (Forecasting)
- NEP-MAC-2008-10-07 (Macroeconomics)
- NEP-RMG-2008-10-07 (Risk Management)
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