18 Pages Posted: 6 May 2005
Date Written: April 2005
The solution adopted in Basel II to deal with procyclicality of capital requirements (i.e. through the cycle ratings and long-run average estimates of default probabilities) implies a reduction in the risk-sensitivity that contradicts the original spirit of the new framework.
In order to preserve risk-sensitivity and to dampen procyclicality at the same time, Pederzoli and Torricelli (2005) set up a model which relies on a business cycle forecast in the estimation of the default probability and provide an application for the US. The modelling approach hinges on a forward-looking definition of capital requirements, in anticipation of the business cycle with a possible smoothing effect on the business cycle turning points.
The present paper checks the robustness of the approach for the Italian case, where alternative business cycles chronologies are used and ratings have to be approximated by exploiting default data provided by the Bank of Italy. Findings suggest that the comparison between the alternative chronologies is an important issue.
Keywords: Basel II, business cycle, capital requirement, default probability, procyclicality
JEL Classification: G21, G28, E32
Suggested Citation: Suggested Citation
Marotta, Giuseppe and Pederzoli, Chiara and Torricelli, Costanza, Forward-looking Estimation of Default Probabilities with Italian Data (April 2005). Available at SSRN: https://ssrn.com/abstract=715921 or http://dx.doi.org/10.2139/ssrn.715921
By Andrew Abel
By Andrew Abel