Empirical credit cycles and capital buffer formation |
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Authors: | Siem Jan Koopman, Andr Lucas,Pieter Klaassen |
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Affiliation: | Siem Jan Koopman, André Lucas,Pieter Klaassen |
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Abstract: | We model 1927–1997 US business failure rates using an unobserved components time series model. Clear evidence is found of cyclical behavior in default rates. We also detect significant longer term movements in default rates and default correlations. In a multi-year backtest experiment we show that accommodation of default rate dynamics has important consequences for credit risk capitalization requirements. Static or myopic variants of credit portfolio models miss significant periods of credit risk accumulation. Empirically congruent dynamic models by contrast provide more timely warning signals of credit risk build-up. In this way they may mitigate some of the pro-cyclicality concerns. |
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Keywords: | Credit risk Capital requirements Dynamic models Common factors Credit cycles Pro-cyclicality |
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