49 Pages Posted: 18 Apr 2007
Date Written: April 18, 2007
This paper develops a flexible and computationally efficient model to estimate the credit loss distribution of the loans in a banking system. 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: Suggested Citation
Mencia, Javier and Jiménez, Gabriel, Modeling the Distribution of Credit Losses With Observable and Latent Factors (April 18, 2007). Banco de España Research Papers, Forthcoming. Available at SSRN: https://ssrn.com/abstract=981109 or http://dx.doi.org/10.2139/ssrn.981109