Dynamic Factor Analysis of Industry Sector Default Rates and Implication for Portfolio Credit Risk Modelling

27 Pages Posted: 22 Jun 2007

See all articles by Andrea Cipollini

Andrea Cipollini

University of Palermo - d/SEAS; Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics; Università degli studi di Modena e Reggio Emilia (UNIMORE) - Center for Research in Banking and Finance (CEFIN)

Giuseppe Missaglia

BNL

Date Written: May 2007

Abstract

In this paper we use a reduced form model for the analysis of Portfolio Credit Risk. For this purpose, we fit a Dynamic Factor model, DF, to a large dataset of default rates proxies and macro-variables for Italy. Multi step ahead density and probability forecasts are obtained by employing both the direct and indirect method of prediction together with stochastic simulation of the DF model. We, first, find that the direct method is the best performer regarding the out of sample projection of financial distressful events. In a second stage of the analysis, the direct method of forecasting through principal components is shown to provide the least sensitive measures of Portfolio Credit Risk to various multifactor model specifications. Finally, the simulation results suggest that the benefits in terms of credit risk diversification tend to diminish with an increasing number of factors, especially when using the indirect method of forecasting.

Keywords: Factor Model, Forecasting, Stochastic Simulation, Risk Management, Banking

JEL Classification: C32, C53, E17, G21, G33

Suggested Citation

Cipollini, Andrea and Missaglia, Giuseppe, Dynamic Factor Analysis of Industry Sector Default Rates and Implication for Portfolio Credit Risk Modelling (May 2007). Available at SSRN: https://ssrn.com/abstract=993967 or http://dx.doi.org/10.2139/ssrn.993967

Andrea Cipollini (Contact Author)

University of Palermo - d/SEAS ( email )

Viale delle Scienze, edificio 13
Palermo, 90124
Italy

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics ( email )

Viale Berengario 51
41100 Modena, Modena 41100
Italy

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Center for Research in Banking and Finance (CEFIN) ( email )

via Berengario 51
Modena, modena I-41100
Italy

Giuseppe Missaglia

BNL ( email )

Rome
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
291
Abstract Views
1,286
rank
106,546
PlumX Metrics