Modeling diversification and spillovers of loan portfolios' losses by LHP approximation and copula

Yongwoong Lee and Kisung Yang

International Review of Financial Analysis, 2019, vol. 66, issue C

Abstract: This paper suggests a top-down method for aggregating the economic capital of an entire banking system and decomposing it into loan sectors according to their risk contributions. We model the individual losses of loan sectors by large homogeneous portfolio (LHP) approximation based on multi-factor skew normal credit worthiness and combine them by applying static and dynamic copulas to reflect diversification effects and spillovers across loan sectors. Our method is more efficient and practically useful than typical multi-factor models using numerical integration due to the latency of risk factors in that losses are directly generated by Monte Carlo simulation using copula without knowing any risk factors.

Keywords: Multi-factor model; Copula; Loss distribution; Diversification; Spillover (search for similar items in EconPapers)
JEL-codes: C51 G20 G32 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:66:y:2019:i:c:s1057521919300894

DOI: 10.1016/j.irfa.2019.101374

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