Stress-Testing Credit Risk Parameters: An Application to Retail Loan Portfolios

Journal of Risk Model Validation, Vol. 1, No. 1, pp. 55-75, 2007

20 Pages Posted: 1 Nov 2011

See all articles by Daniel Roesch

Daniel Roesch

University of Regensburg

Harald (Harry) Scheule

University of Technology Sydney (UTS) - School of Finance and Economics; Financial Research Network

Date Written: April 24, 2007

Abstract

Financial institutions are faced with the challenge to forecast future credit portfolio losses. It is common practice to focus on portfolio models consisting of a limited set of parameters, such as the probability of default, asset correlation, loss given default or exposure at default. A simple portfolio model is also used in the Basel II framework for calculating regulatory capital. With regard to the stability of the financial system, these models have to be approved by regulators who have an interest in a conservative assessment of the credit portfolio risk and require the stress-testing of risk estimates. The present paper is the first in its kind to develop a framework to stress the smallest building block, the sensitivities of risk drivers and therefore any derivative such as a risk parameter or the credit portfolio loss. As a result, estimation uncertainties as well as the correlations are taken into account. In an empirical analysis, the stress scenarios for different loan categories are analyzed for US retail borrowers and the implications on economic as well as regulatory capital explored.

Keywords: Basel II, Business Cycle, Capital Adequacy, Correlation, Credit Risk, Default Probability, Expected Loss, Stress-test, Value-at-Risk

JEL Classification: G20, G28, C51

Suggested Citation

Roesch, Daniel and Scheule, Harald, Stress-Testing Credit Risk Parameters: An Application to Retail Loan Portfolios (April 24, 2007). Journal of Risk Model Validation, Vol. 1, No. 1, pp. 55-75, 2007, Available at SSRN: https://ssrn.com/abstract=1951850 or http://dx.doi.org/10.2139/ssrn.1951850

Daniel Roesch

University of Regensburg ( email )

Chair of Statistics and Risk Management
Faculty of Business, Economics and BIS
Regensburg, 93040
Germany

HOME PAGE: http://www-risk.ur.de/

Harald Scheule (Contact Author)

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

P.O. Box 123
Broadway, NSW 2007
Australia

HOME PAGE: http://https://www.uts.edu.au/staff/harald.scheule

Financial Research Network ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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