Modelling the Distribution of Credit Losses with Observable and Latent Factors

38 Pages Posted: 8 Feb 2007

Date Written: February 7, 2007

Abstract

This paper develops a flexible and computationally efficient model to estimate the credit loss distribution of the banking industry. We consider a sectorial structure, where default frequencies and the total number of loans are allowed to depend on macroeconomic conditions as well as on unobservable credit risk factors, which can capture contagion effects between sectors. In addition, we also model the distributions of the Exposure at Default and the Loss Given Default. We apply our model to the Spanish credit market, where we find that sectorial default frequencies are affected by a persistent latent factor. Finally, we also identify the potentially riskier sectors and perform stress tests.

Keywords: Credit risk, Probability of default, Loss distribution, Stress test, Contagion

JEL Classification: G21, E32, E37

Suggested Citation

Mencia, Javier and Jimenez, Gabriel, Modelling the Distribution of Credit Losses with Observable and Latent Factors (February 7, 2007). Available at SSRN: https://ssrn.com/abstract=961788 or http://dx.doi.org/10.2139/ssrn.961788

Javier Mencia

Banco de España ( email )

Alcala 50
Madrid 28014
Spain
+34 91 338 5414 (Phone)
+34 91 338 6104 (Fax)

HOME PAGE: http://www.bde.es/investigador/staff/66.htm

Gabriel Jimenez (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

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