An intensity-based non-parametric default model for residential mortgage portfolios

ABSTRACT In June 2003 Swiss banks held over Sfr 500 billion in mortgages. This important sector accounts for about 63% of all loan portfolios held by Swiss banks. Since default insurance is not common in Switzerland, the corresponding risks are a severe threat to the health of the financial system. We focus on the analysis of portfolios of residential mortgages and model the probability distribution of the number of defaults using a non-parametric approach, where the intensity processes associated with the time-to-default are linked to a set of predictors through general smooth functions. A generalized additive model is used to condition default intensities of mortgages on relevant economic risk drivers. We calibrate our model on a large mortgage servicing data set and compare the resulting loss distributions to a well-known benchmark – the loss distribution obtained from CreditRisk+ as commonly applied in the industry. The conditional loss distribution and risk measures for a large mortgage portfolio are shown to be highly sensitive to the prevailing socioeconomic conditions.