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Incorporating prediction and estimation risk in point-in-time credit portfolio models

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  • Hamerle, Alfred
  • Knapp, Michael
  • Liebig, Thilo
  • Wildenauer, Nicole

Abstract

In this paper we focus on the analysis of the effect of prediction and estimation risk on the loss distribution, risk measures and economic capital. When variables for the determination of probability of default and loss distribution have to be predicted because they are not available at the time the prediction is made, the prediction is prone to errors. The model parameters for the estimation of probability of default or asset correlation are not available, and usually have to be estimated using historical data. The incorporation of prediction and estimation risk generally leads to broader loss distributions and therefore to rising values of risk parameters such as Value at Risk or Expected Shortfall. The level of economic capital required may be strongly underestimated if prediction and estimation risk are ignored. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2005,13.

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Date of creation: 2005
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Handle: RePEc:zbw:bubdp2:4268

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Keywords: probability of default; PD; credit risk; default correlation; asset correlation; point in time; value at risk; estimation risk;

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References

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  1. Fecht, Falko & Huang, Kevin & Martin, Antoine, 2005. "Financial intermediaries, markets and growth," Discussion Paper Series 1: Economic Studies 2005,03, Deutsche Bundesbank, Research Centre.
  2. John Y. Campbell & Jens Hilscher & Jan Szilagyi, 2008. "In Search of Distress Risk," Journal of Finance, American Finance Association, vol. 63(6), pages 2899-2939, December.
  3. Koetter, M. & Bos, J.W.B. & Heid, F. & Kolari, J.W. & Kool, C.J.M. & Porath, D., 2007. "Accounting for distress in bank mergers," Journal of Banking & Finance, Elsevier, vol. 31(10), pages 3200-3217, October.
  4. Slacalek, Jirka & Fritsche, Ulrich & Dovern, Jonas & Döpke, Jörg, 2005. "European inflation expectations dynamics," Discussion Paper Series 1: Economic Studies 2005,37, Deutsche Bundesbank, Research Centre.
  5. Hamerle, Alfred & Liebig, Thilo & Scheule, Harald, 2004. "Forecasting Credit Portfolio Risk," Discussion Paper Series 2: Banking and Financial Studies 2004,01, Deutsche Bundesbank, Research Centre.
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Cited by:
  1. Henry Dannenberg, 2009. "Berücksichtigung von Schätzunsicherheit bei der Kreditrisikobewertung: Vergleich des Value at Risk der Verlustverteilung des Kreditrisikos bei Verwendung von Bootstrapping und einem asymptotischen A," IWH Discussion Papers 3, Halle Institute for Economic Research.
  2. Henry Dannenberg, 2011. "The Importance of Estimation Uncertainty in a Multi-Rating Class Loan Portfolio," IWH Discussion Papers 11, Halle Institute for Economic Research.

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