Forward-looking Estimation of Default Probabilities with Italian Data
Department of Economics Marco Biagi and CEFIN; Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics
Università degli Studi di Milano-Bicocca - Istituto di Economia Amministrazione e Politica Aziendale
University of Modena and Reggio Emilia - Department of Economics; Università degli studi di Modena e Reggio Emilia (UNIMORE) - Center for Research in Banking and Finance (CEFIN); Center for Research on Pensions and Welfare Policies (CeRP)
The solution adopted in Basel II to deal with procyclicality of capital requirements (i.e. through the cycle ratings and long-run average estimates of default probabilities) implies a reduction in the risk-sensitivity that contradicts the original spirit of the new framework.
In order to preserve risk-sensitivity and to dampen procyclicality at the same time, Pederzoli and Torricelli (2005) set up a model which relies on a business cycle forecast in the estimation of the default probability and provide an application for the US. The modelling approach hinges on a forward-looking definition of capital requirements, in anticipation of the business cycle with a possible smoothing effect on the business cycle turning points.
The present paper checks the robustness of the approach for the Italian case, where alternative business cycles chronologies are used and ratings have to be approximated by exploiting default data provided by the Bank of Italy. Findings suggest that the comparison between the alternative chronologies is an important issue.
Number of Pages in PDF File: 18
Keywords: Basel II, business cycle, capital requirement, default probability, procyclicality
JEL Classification: G21, G28, E32
Date posted: May 6, 2005
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