Capital requirements and business cycle regimes: Forward-looking modelling of default probabilities

By C. Pederzoli, Costanza Torricelli. 2005

140 citations recorded by the source corpus.

Abstract This paper proposes a forward-looking model for time-varying capital requirements, which finds application within Basel II. The model rests on the relationship between default rates and the business cycle: by positing two regimes, expansion and recession, and by forecasting the associated probabilities, the default probability for each rating class is defined as the expected value of a default rate whose distribution is a mixture of an expansion and a recession distribution. The application to US data over the forecasting period 1971–2002 provides evidence that the model makes it possible to preserve the risk sensitivity of the capital requirement and at the same time to dampen procyclicality.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/b8577c95d6bb9cd99c8c6b8e116372ca8f8ae2ce

Citations in the corpus

• Credit Risk Drivers: Evaluating the Contribution of Firm Level Information and of Macroeconomic Dynamics (2009, unknown): “Some authors, such as Pederzoli and Torricelli (2005), Jiménez and Saurina (2006), Kent and D’Arcy (2001) or Borio et al (2001) argue that high default rates during recessions are just a materialisation of the risk that is built up during expansions, most notably when strong economic growth is…”
• Asymmetric effects of the business cycle on bank credit risk. (2009, unknown): “Pederzoli and Torricelli (2005) adopt a similar framework to assess the impact of the business cycle on capital requirements under Basel 2.”