Modeling agricultural loan portfolio risk in a stochastic environment

Abstract

A simulation methodology is applied to the loan loss reserve process of an agricultural lender. Weaknesses of the point‐estimate approach to estimating loan loss reserves are addressed with a “bottom‐up” model. Modeling includes consideration of the producer’s and the lender’s diversification efforts. Implementation of this model will provide the lender a better understanding of the institution’s portfolio risk, as well as the credit risk associated with each loan. This study compares the lender’s loan loss estimates to a distribution of losses with associated probabilities. The comparative results could provide the lender a basis for setting probability levels for determining the regulatory required level of loan loss reserve.

Citation

Gallagher, R.L. (2002), "Modeling agricultural loan portfolio risk in a stochastic environment", Agricultural Finance Review, Vol. 62 No. 1, pp. 25-39. https://doi.org/10.1108/00214860280001127