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Volume 62, Issue 2

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Dynamic Multi-Factor Credit Risk Model with Fat-Tailed Factors

Gapko, Petr; Šmíd, Martin

Year: 2012   Volume: 62   Issue: 2   Pages: 125-140

Abstract: The authors introduce an improved multi-factor credit risk model describing simultaneously the default rate and the loss given default. Their methodology is based on the KMV model, which they generalize in three ways. First, they add a model for loss given default (LGD), second, they bring dynamics to the model, and third, they allow non-normal distributions of risk factors. Both the defaults and the LGD are driven by a common factor and an individual factor; the individual factors are mutually independent, but the authors allow any form of dependence of the common factors. They test their model on a nationwide portfolio of US mortgage delinquencies, modeling the dependence of the common factor by a VECM model, and compare their results with the current regulatory framework, which is described in the Basel II Accord.

JEL classification: G21, C58

Keywords: credit risk, probability of default, loss given default, credit loss, credit loss distribution, Basel II

RePEc: http://ideas.repec.org/a/fau/fauart/v62y2012i2p125-140.html

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