Measuring bank capital requirements through Dynamic Factor analysis

Andrea Cipollini and Giuseppe Missaglia ()

Center for Economic Research (RECent) from University of Modena and Reggio E., Dept. of Economics "Marco Biagi"

Abstract: In this paper, using industry sector stock returns as proxies of firm asset values, we obtain bank capital requirements (through the cycle). This is achieved by Montecarlo simulation of a bank loan portfolio loss density. We depart from the Basel 2 analytical formula developed by Gordy (2003) for the computation of the economic capital by, first, allowing dynamic heterogeneity in the factor loadings, and, also, by accounting for stochastic dependent recoveries. Dynamic heterogeneity in the factor loadings is introduced by using dynamic forecast of a Dynamic Factor model fitted to a large dataset of macroeconomic credit drivers. The empirical findings show that there is a decrease in the degree of Portfolio Credit Risk, once we move from the Basel 2 analytic formula to the Dynamic Factor model specification.

Keywords: Dynamic Factor Model; Forecasting; Stochastic Simulation; Risk Management; Banking (search for similar items in EconPapers)
JEL-codes: C32 C53 E17 G21 G33 (search for similar items in EconPapers)
Pages: pages 26
Date: 2008-02
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cfn, nep-for, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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