EconPapers    
Economics at your fingertips  
 

Systematic Effects among Loss Given Defaults and their Implications on Downturn Estimation

Jennifer Betz, Ralf Kellner and Daniel Rösch

European Journal of Operational Research, 2018, vol. 271, issue 3, 1113-1144

Abstract: Banks are obliged to provide downturn estimates for loss given defaults (LGDs) in the internal ratings-based approach. While downturn conditions are characterized by systematically higher LGDs, it is unclear which factors may best capture these conditions. As LGDs depend on recovery payments which are collected during varying economic conditions in the resolution process, it is challenging to identify suitable economic variables. Using a Bayesian Finite Mixture Model, we adapt random effects to measure economic conditions and to generate downturn estimates. We find that systematic effects vary among regions, i.e., the US and Europe, and strongly deviate from the economic cycle. Our approach offers straightforward supportive tools for decision makers. Risk managers are enabled to select their individual margin of conservatism based on their portfolios, while regulators might set a lower bound to guarantee conservatism. In comparison to other approaches, our proposal appears to be conservative enough during downturn conditions and inhibits over-conservatism.

Keywords: Risk management; Bank loans; Credit risk; Random effects (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0377221718304788
Full text for ScienceDirect subscribers only

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:eee:ejores:v:271:y:2018:i:3:p:1113-1144

Access Statistics for this article

European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati

More articles in European Journal of Operational Research from Elsevier
Bibliographic data for series maintained by Dana Niculescu ().

 
Page updated 2018-11-10
Handle: RePEc:eee:ejores:v:271:y:2018:i:3:p:1113-1144