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Modelling the distribution of credit losses with observable and latent factors

  • Jiménez, Gabriel
  • Mencía, Javier
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    This paper proposes a dynamic model to estimate the credit loss distribution of the aggregate portfolio of loans granted in a banking system. We consider a sectoral approach distinguishing between corporates and households. The evolution of their default frequencies and the size of the loans portfolio are expressed as functions of macroeconomic conditions as well as unobservable credit risk factors, which capture contagion effects between sectors. In addition, we model the distributions of the Exposures at Default and the Losses Given Default. We apply our framework to the Spanish banking system, where we find that sectoral default frequencies are not only affected by economic cycles but also by a persistent latent factor. Finally, we identify the riskier sectors, perform stress tests and compare the relative risk of small and large institutions.

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    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 16 (2009)
    Issue (Month): 2 (March)
    Pages: 235-253

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    Handle: RePEc:eee:empfin:v:16:y:2009:i:2:p:235-253
    Contact details of provider: Web page: http://www.elsevier.com/locate/jempfin

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    1. Anil Kashyap & Jeremy C. Stein, 2004. "Cyclical implications of the Basel II capital standards," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 18-31.
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    7. Gordy, Michael B. & Howells, Bradley, 2006. "Procyclicality in Basel II: Can we treat the disease without killing the patient?," Journal of Financial Intermediation, Elsevier, vol. 15(3), pages 395-417, July.
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    18. repec:cup:cbooks:9780521321969 is not listed on IDEAS
    19. Bruche, Max & González-Aguado, Carlos, 2010. "Recovery rates, default probabilities, and the credit cycle," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 754-764, April.
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    22. Gabriel Jiménez & Jesús Saurina, 2004. "Collateral, type of lender and relationship banking as determinants of credit risk," Banco de Espa�a Working Papers 0414, Banco de Espa�a.
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