Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing Under Data-Restricted Environments

December 1, 2006

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Miguel A. Segoviano Portfolio Credit Risk and Macroeconomic Shocks: Applications to Stress Testing Under Data-Restricted Environments, (USA: International Monetary Fund, 2006) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Portfolio credit risk measurement is greatly affected by data constraints, especially when focusing on loans given to unlisted firms. Standard methodologies adopt convenient, but not necessarily properly specified parametric distributions or simply ignore the effects of macroeconomic shocks on credit risk. Aiming to improve the measurement of portfolio credit risk, we propose the joint implementation of two new methodologies, namely the conditional probability of default (CoPoD) methodology and the consistent information multivariate density optimizing (CIMDO) methodology. CoPoD incorporates the effects of macroeconomic shocks into credit risk, recovering robust estimators when only short time series of loans exist. CIMDO recovers portfolio multivariate distributions (on which portfolio credit risk measurement relies) with improved specifications, when only partial information about borrowers is available. Implementation is straightforward and can be very useful in stress testing exercises (STEs), as illustrated by the STE carried out within the Danish Financial Sector Assessment Program.

Subject: Asset and liability management, Asset valuation, Banking, Credit, Credit risk, Financial institutions, Financial regulation and supervision, Financial sector policy and analysis, Loans, Money, Stress testing

Keywords: Asset valuation, Bank portfolio UL, Capital adequacy ratio, Concentration effect, Credit, Credit portfolio, Credit risk, Credit risk modeling, Credit risk quality, Economic theory, Entropy distribution, Europe, Importance of portfolio credit risk, Loan default, Loan portfolio, Loans, Loss distribution, Macroeconomic shock measurement, Multivariate density estimation, Multivariate distribution, Portfolio credit risk, Portfolio credit risk measurement, Stress testing, Time series, WP

Publication Details

Pages:

50
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/283
Stock No:

WPIEA2006283
ISBN:

9781451865431
ISSN:

1018-5941

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