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Forward-looking estimation of default probabilities with Italian data

Author

Listed:
  • Giuseppe Marotta
  • Chiara Pederzoli
  • Costanza Torricelli

Abstract

The solution adopted in Basel II to deal with procyclicality of capital requirements (i.e. through the cycle ratings and long-run average estimates of default probabilities) implies a reduction in the risk-sensitivity that contradicts the original spirit of the new framework.In order to preserve risk-sensitivity and to dampen procyclicality at the same time, Pederzoli and Torricelli (2005) set up a model which relies on a business cycle forecast in the estimation of the default probability and provide an application for the US. The modelling approach hinges on a forward-looking definition of capital requirements, in anticipation of the business cycle with a possible smoothing effect on the business cycle turning points.The present paper checks the robustness of the approach for the Italian case, where alternative business cycles chronologies are used and ratings have to be approximated by exploiting default data provided by the Bank of Italy. Findings suggest that the comparison between the alternative chronologies is an important issue.

Suggested Citation

  • Giuseppe Marotta & Chiara Pederzoli & Costanza Torricelli, 2005. "Forward-looking estimation of default probabilities with Italian data," Heterogeneity and monetary policy 0504, Universita di Modena e Reggio Emilia, Dipartimento di Economia Politica.
    • Handle: RePEc:mod:modena:0504
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    Cited by:

    1. Cipollini, Andrea & Missaglia, Giuseppe, 2007. "Dynamic Factor analysis of industry sector default rates and implication for Portfolio Credit Risk Modelling," MPRA Paper 3582, University Library of Munich, Germany.
    2. Petr Jakubík, 2006. "Does Credit Risk Vary with Economic Cycles? The Case of Finland," Working Papers IES 2006/11, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Apr 2006.
    3. Costanza Torricelli & Marianna Brunetti, 2006. "Economic activity and Recession Probabilities: spread predictive power in Italy," Computing in Economics and Finance 2006 350, Society for Computational Economics.
    4. Petr Jakubík, 2007. "Credit Risk and the Finnish Economy," Czech Economic Review, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, vol. 1(3), pages 254-285, November.
    5. Chiara Pederzoli, 2007. "Default risk: Poisson mixture and the business cycle," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 07052, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".

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    More about this item

    Keywords

    Basel II; business cycle; capital requirement; default probability; procyclicality;
    All these keywords.

    JEL classification:

    • 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
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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