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Considering the dependence between the credit loss severity and the probability of default in the estimate of portfolio credit risk: an experimental analysis

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  • Annalisa Di Clemente

Abstract

In this paper a simple and innovative model for measuring more accurately the credit tail risk of a banking book is presented. This is a Monte Carlo simulation model in which the credit loss severity (LGD) is a stochastic variable and it is correlated to the default event. Specifically, LGD is assumed to be distributed as a conditional beta function and its two parameters a and b are estimated assuming a mean value of LGD linked to the value of the PD conditional to the value of the macro-economic risk factor generated in every Monte Carlo simulative scenario. The linkage between the average LGD and the conditional PD is obtained by a simple linear regression analysis calibrated by using the time series of easily available financial historical data (Moody?s, 2011; Standard & Poor?s, 2012).

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  • Annalisa Di Clemente, 2013. "Considering the dependence between the credit loss severity and the probability of default in the estimate of portfolio credit risk: an experimental analysis," STUDI ECONOMICI, FrancoAngeli Editore, vol. 2013(109), pages 5-24.
    • Handle: RePEc:fan:steste:v:html10.3280/ste2013-109001
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    More about this item

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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