Forecasting Expected and Unexpected Losses

57 Pages Posted: 14 Jan 2021

See all articles by Mikael Juselius

Mikael Juselius

Bank of Finland

Nikola Tarashev

Bank for International Settlements (BIS)

Date Written: December 21, 2020

Abstract

Extending a standard credit-risk model illustrates that a single factor can drive both expected losses and the extent to which they may be exceeded in extreme scenarios, ie “unexpected losses.” This leads us to develop a framework for forecasting these losses jointly. In an application to quarterly US data on loan charge-offs from 1985 to 2019, we find that financial-cycle indicators – notably, the debt service ratio and credit-to-GDP gap – deliver reliable real-time forecasts, signalling turning points up to three years in advance. Provisions and capital that reflect such forecasts would help reduce the procyclicality of banks’ loss-absorbing resources.

JEL Classification: G17, G21, G28

Suggested Citation

Juselius, Mikael and Tarashev, Nikola, Forecasting Expected and Unexpected Losses (December 21, 2020). Bank of Finland Research Discussion Paper No. 18/2020, Available at SSRN: https://ssrn.com/abstract=3764723

Mikael Juselius (Contact Author)

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Nikola Tarashev

Bank for International Settlements (BIS)

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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