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Stress-testing credit risk parameters: An application to retail loan portfolios

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Abstract

Financial institutions are faced with the challenge to forecast future credit portfolio losses. It is common practice to focus on portfolio models consisting of a limited set of parameters, such as the probability of default, asset correlation, loss given default or exposure at default. A simple portfolio model is also used in the Basel II framework for calculating regulatory capital. With regard to the stability of the financial system, these models have to be approved by regulators who have an interest in a conservative assessment of the credit portfolio risk and require the stress-testing of risk estimates. The present paper is the first in its kind to develop a framework to stress the smallest building block, the sensitivities of risk drivers and therefore any derivative such as a risk parameter or the credit portfolio loss. As a result, estimation uncertainties as well as the correlations are taken into account. In an empirical analysis, the stress scenarios for different loan categories are analyzed for US retail borrowers and the implications on economic as well as regulatory capital explored.

Suggested Citation

  • Daniel Roesch & Harald Scheule, 2007. "Stress-testing credit risk parameters: An application to retail loan portfolios," Published Paper Series 2007-1, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    • Handle: RePEc:uts:ppaper:2007-1
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    Cited by:

    1. Cornaglia, Anna & Morone, Marco, 2009. "Rating philosophy and dynamic properties of internal rating systems: A general framework and an application to backtesting," MPRA Paper 14711, University Library of Munich, Germany.
    2. Pawel Siarka, 2012. "Implementation of the Stress Test Methods in the Retail Portfolio," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 2(6), pages 1-2.
    3. Ahmad Raza Bilal & Noraini Bt. Abu Talib & Mohd Noor Azli Ali Khan, 2013. "Remodeling of risk management in banking: evidence from the sub-continent and gulf," Journal of Risk Finance, Emerald Group Publishing, vol. 14(5), pages 468-489, November.
    4. repec:zbw:bofitp:2011_007 is not listed on IDEAS
    5. J. Crook & T. Bellotti, 2012. "Asset correlations for credit card defaults," Applied Financial Economics, Taylor & Francis Journals, vol. 22(2), pages 87-95, January.
    6. Steffi Höse & Stefan Huschens, 2011. "Confidence Intervals for Asset Correlations in the Asymptotic Single Risk Factor Model," Operations Research Proceedings, in: Bo Hu & Karl Morasch & Stefan Pickl & Markus Siegle (ed.), Operations Research Proceedings 2010, pages 111-116, Springer.
    7. Joseph L Breeden & Lyn Thomas, 2016. "Solutions to specification errors in stress testing models," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 67(6), pages 830-840, June.
    8. Yonghan Ju & So Young Sohn, 2015. "Stress test for a technology credit guarantee fund based on survival analysis," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 66(3), pages 463-475, March.
    9. Petr Jakubík, 2011. "Household Balance Sheets and Economic Crisis," Working Papers IES 2011/20, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jun 2011.
    10. NUCU, Anca Elena, 2011. "Managementul riscului de creditare: realizari actuale, analiza critica, sugestii [Credit risk management: current achievements, critical analysis, suggestions]," MPRA Paper 27932, University Library of Munich, Germany.
    11. Jakubik, Petr, 2011. "Households response to economic crisis," BOFIT Discussion Papers 7/2011, Bank of Finland Institute for Emerging Economies (BOFIT).
    12. Carole Bernard & Ludger Rüschendorf & Steven Vanduffel & Jing Yao, 2017. "How robust is the value-at-risk of credit risk portfolios?," The European Journal of Finance, Taylor & Francis Journals, vol. 23(6), pages 507-534, May.
    13. Agata Gemzik-Salwach, 2012. "The Use Of A Value At Risk Measure For The Analysis Of Bank Interest Margins," "e-Finanse", University of Information Technology and Management, Institute of Financial Research and Analysis, vol. 8(4), pages 15-29, February.
    14. Mager, Ferdinand & Schmieder, Christian, 2008. "Stress testing of real credit portfolios," Discussion Paper Series 2: Banking and Financial Studies 2008,17, Deutsche Bundesbank.
    15. Jakubik, Petr, 2011. "Households response to economic crisis," BOFIT Discussion Papers 7/2011, Bank of Finland, Institute for Economies in Transition.
    16. Pawel Siarka, 2021. "Global Portfolio Credit Risk Management: The US Banks Post-Crisis Challenge," Mathematics, MDPI, vol. 9(5), pages 1-19, March.
    17. Lützenkirchen, Kristina & Rösch, Daniel & Scheule, Harald, 2014. "Asset portfolio securitizations and cyclicality of regulatory capital," European Journal of Operational Research, Elsevier, vol. 237(1), pages 289-302.
    18. Petr Jakubik & Christian Schmieder, 2008. "Stress Testing Credit Risk: Is the Czech Republic Different from Germany?," Working Papers 2008/9, Czech National Bank.
    19. Yashkir, Olga & Yashkir, Yuriy, 2013. "Loss Given Default Modelling: Comparative Analysis," MPRA Paper 46147, University Library of Munich, Germany.

    More about this item

    Keywords

    Basel II; Business Cycle; Capital Adequacy; Correlation; Credit Risk; Default Probability; Expected Loss; Stress-test; Value-at-Risk;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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