Modelling the Distribution of Credit Losses with Observable and Latent Factors
38 Pages Posted: 8 Feb 2007
Date Written: February 7, 2007
Abstract
This paper develops a flexible and computationally efficient model to estimate the credit loss distribution of the banking industry. We consider a sectorial structure, where default frequencies and the total number of loans are allowed to depend on macroeconomic conditions as well as on unobservable credit risk factors, which can capture contagion effects between sectors. In addition, we also model the distributions of the Exposure at Default and the Loss Given Default. We apply our model to the Spanish credit market, where we find that sectorial default frequencies are affected by a persistent latent factor. Finally, we also identify the potentially riskier sectors and perform stress tests.
Keywords: Credit risk, Probability of default, Loss distribution, Stress test, Contagion
JEL Classification: G21, E32, E37
Suggested Citation: Suggested Citation
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