A Framework for Integrating Extreme Weather Risk, Probability of Default, and Loss Given Default for Residential Mortgage Loans

Michael C. S. Wong () and Ho Ming Ho
Additional contact information
Michael C. S. Wong: Department of Economics and Finance, City University of Hong Kong, Kowloon Tong, Hong Kong, China
Ho Ming Ho: College of Business, City University of Hong Kong, Kowloon Tong, Hong Kong, China

Sustainability, 2023, vol. 15, issue 15, 1-16

Abstract: This paper considers a hypothetical case in which a bank wants to build a routine climate stress test exercise on residential mortgage loans. The bank has regularly updated the probability of default (PD) and loss given default (LGD) on each residential mortgage loan under the internal-rating-based (IRB) approach of Basel II/III. Additionally, the bank estimates the stressed PD and stressed LGD associated with a predetermined extreme weather event. Using simulation techniques, this paper shows that the loss of the bank’s residential mortgage portfolio can reach a median of around 36% of the portfolio value. This remarkable loss comes from the effects of default correlation and property damage. Banks should pay more attention to such impacts of extreme weather events.

Keywords: physical climate risk; residential mortgage loans; probability of default; loss given default; climate stress tests (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.mdpi.com/2071-1050/15/15/11808/pdf (application/pdf)
https://www.mdpi.com/2071-1050/15/15/11808/ (text/html)

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:gam:jsusta:v:15:y:2023:i:15:p:11808-:d:1207974

Access Statistics for this article

Sustainability is currently edited by Ms. Alexandra Wu

More articles in Sustainability from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().