Credit Risk Characteristics of US Small Business Portfolios

39 Pages Posted: 20 Oct 2015

See all articles by Dennis Bams

Dennis Bams

Maastricht University - Department of Finance; DLL

Magdalena Pisa

WHU - Otto Beisheim School of Management

Christian C. P. Wolff

University of Luxembourg - Luxembourg School of Finance; Centre for Economic Policy Research (CEPR)

Date Written: October 2015

Abstract

This paper addresses issues related to industry heterogeneity, default clustering and parameter uncertainty of capital requirements in US retail loan portfolios. Using a multi-factor model of credit risk, we show that the Basel II capital requirements overstate the riskiness of small businesses. Retail exposures are a much safer investment than the regulator would suggest. We find that sensitivity to the common risk factors is low and that small business risk is predominantly a reflection of idiosyncratic risk. Our results show that only 0.00-3.39% of the asset variability is explained by economy-wide risk factors. The remaining 96.61%-100.00% of small business risk is due to changes in the firm-specific characteristics. Moreover, both expected and unexpected losses are time dependent. Their shifts over the course of financial crisis cause uncertainty in the provisions level and capital requirements. Importantly, our estimates of asset correlations are significantly lower than any available estimates for corporate firms. Our results are based on a new, representative dataset of US retail businesses from 2005 to 2011 and give fundamental insights into the US economy.

Keywords: capital requirements

JEL Classification: G17, L14, L25

Suggested Citation

Bams, Dennis and Pisa, Magdalena and Wolff, Christian C. P., Credit Risk Characteristics of US Small Business Portfolios (October 2015). CEPR Discussion Paper No. DP10889. Available at SSRN: https://ssrn.com/abstract=2676595

Dennis Bams (Contact Author)

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

DLL ( email )

Eindhoven
Netherlands

Magdalena Pisa

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallendar, 56179
Germany

Christian C. P. Wolff

University of Luxembourg - Luxembourg School of Finance ( email )

4, rue Albert Borschette
Luxembourg, 1246
Luxembourg

HOME PAGE: http://www.lsf.lu

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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