Macro stress test for credit risk
Abstract
Purpose
The purpose of this study is to analyze the benchmark model and offer a practical implementation of the macro stress test. The emergence of complicated instruments such as securitized products has rendered the risk management methodologies used in non-crisis periods insufficient. The macro stress test has become prominent as both an internal risk management tool for financial institutions and a way for supervisory authorities to maintain financial stability. However, no practical model is available for transforming macro stress scenarios into the risk parameters of an institution’s internal model.
Design/methodology/approach
This study presents a model for assessing a company’s default risk through a multi-level regression based on simultaneous estimates of the impacts of company-specific, macroeconomic and sector-specific risk factors using panel and time series data.
Findings
Equity capital, EBITDA, the current ratio and the fixed assets to fixed liability ratio are selected as the company-specific factors, while the CPI core rate, overall unemployment rate, overnight call rate and JGB yield to subscribers are selected as the macroeconomic factors. The correlation coefficients among the latent sector factors are significant at 5 per cent. In addition, the accuracy ratio values prove that the presented model has more default prediction power than do models without them.
Originality/value
This study is the first to provide a benchmark model for incorporating macroeconomic variables into a credit risk model for use in a bottom-up macro stress test.
Keywords
Acknowledgements
An earlier version of this paper was presented at the 21st Global Finance Conference on March 31, 2014, in Dubai and at the 6th International Finance and Banking Society Conference on June 18, 2014, in Lisbon. The author thanks the participants of both conferences for their insightful suggestions for revisions. The author also thanks the anonymous reviewers. The author receives research grants from the Japan Securities Scholarship Foundation and KAKENHI No. 26380408. This assistance is sincerely appreciated.
Citation
Kanno, M. (2015), "Macro stress test for credit risk", Journal of Risk Finance, Vol. 16 No. 5, pp. 554-574. https://doi.org/10.1108/JRF-11-2014-0170
Publisher
:Emerald Group Publishing Limited
Copyright © 2015, Emerald Group Publishing Limited