PREDICTING THE PROBABILITY OF DEFAULT USING ASSET CORRELATION OF A LOAN PORTFOLIO

Pankaj Baag ()
Additional contact information
Pankaj Baag: Indian Institute of Management Kozhikode

No 151, Working papers from Indian Institute of Management Kozhikode

Abstract: We use the asymptotic single risk factor model, which is a portfolio invariant model and preferred by BCBS with the factor based structural CreditMetrics portfolio default model to empirically estimate the Probability of default with asset correlation of a loan portfolio based on primary data from Public Sector Banks and compared the results with the estimated Probability of default without any asset correlation. We have used actual bank loan rating transition data for the period 2000-2010. Our study evidences that probability of default improves with asset correlation. We also find that asset correlation is an increasing function of probability of default. High rating firms have low correlation than low rating firms. These are opposite of BCBS assumptions for the developed nations. This implies that large corporate loans have the same systematic risk in times of economy distress. Our analyses suggest that it is imprudent to assume a decreasing relationship between average asset correlation and default probability in measuring portfolio credit risk. In light of this empirical evidence, we encourage the Basel Committee to revisit the use of this relationship in bank capital requirement.

Pages: 27 pages
Date: 2014
New Economics Papers: this item is included in nep-ban and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://iimk.ac.in/websiteadmin/FacultyPublication ... pers/151abs.pdf?t=24

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:iik:wpaper:151

Access Statistics for this paper

More papers in Working papers from Indian Institute of Management Kozhikode IIMK Campus PO, Kunnamanagalam, Kozhikode, Kerala, India -673570. Contact information at EDIRC.
Bibliographic data for series maintained by Sudheesh Kumar ().