Modeling Credit Losses for Multiple Loan Portfolios

31 Pages Posted: 14 Feb 2018

See all articles by Petr Gapko

Petr Gapko

Charles University in Prague - Department of Economics

Martin Smid

Institute of Information Theory and Automation, Prague

Date Written: February 2, 2018

Abstract

We propose a dynamic structural model of credit risk of multiple loan portfolios. In line with Merton, Vasicek and Pykhtin, we assume that a loan defaults if the assets of the debtor fall below his liabilities, and that the subsequent loss given default is determined by the collateral value. For each loan, the assets, liabilities and the collateral value each depends on a common and an individual factor. The common factors are interdependent, possibly dependent on exogenous (macroeconomic) variables. Consequently, the credit risk of each portfolio, quantified by default rate and loss given default, possibly depends not only on the exogenous variables, but also on historical credit losses of the portfolios.

By applying our model to two nationwide US loan portfolios with real estate collateral, we demonstrate its considerable predicting power and we show that the hypothetical economic capital needed to withstand the 99.9 quantile loss is lower compared to the regulatory IRB approach; this suggests that using our model could lead to considerable savings for loan providers.

Keywords: Credit Risk, Mortgage, Loan Portfolio, Dynamic Model, Estimation, Interconnectedness, Cointegration

JEL Classification: G32

Suggested Citation

Gapko, Petr and Smid, Martin, Modeling Credit Losses for Multiple Loan Portfolios (February 2, 2018). Available at SSRN: https://ssrn.com/abstract=3117107 or http://dx.doi.org/10.2139/ssrn.3117107

Petr Gapko (Contact Author)

Charles University in Prague - Department of Economics ( email )

Opletalova 26
Prague, 11000
Czech Republic

HOME PAGE: http://ies.fsv.cuni.cz

Martin Smid

Institute of Information Theory and Automation, Prague ( email )

Pod vodarenskou vezi 4
Praha, CZ-18208
Czech Republic

HOME PAGE: http://www.klec.cz/martin

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