Mortgages: estimating default correlation and forecasting default risk

Tobias Neumann
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Tobias Neumann: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 708, Bank of England working papers from Bank of England

Abstract: Default correlation is a key driver of credit risk. In the Basel regulatory framework it is measured by the asset value correlation parameter. Though past studies suggest that the parameter is over-calibrated for mortgages — generally the largest asset class on banks’ balance sheets — they do not take into account bias arising from small samples or non-Gaussian risk factors. Adjusting for these biases using a non-Gaussian, non-linear state space model I find that the Basel calibration is appropriate for UK and US mortgages. This model also forecasts mortgage default rates accurately and parsimoniously. The model generates value-at-risk estimates for future mortgage default rates, which can be used to inform stress-testing and macroprudential policy.

Keywords: Mortgages; bank regulation; credit risk; default correlation; state space model; Basel Committee; stress testing; macroprudential policy (search for similar items in EconPapers)
JEL-codes: G11 G17 G21 G28 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2018-02-09
New Economics Papers: this item is included in nep-ban, nep-for, nep-mac, nep-rmg and nep-ure
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