Journal of Risk

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An intensity-based non-parametric default model for residential mortgage portfolios

Jürg Burkhard, Enrico De Giorgi

ABSTRACT

In June 2003 Swiss banks held over Sfr 500 billion in mortgages. This important sector accounts for about 63% of all loan portfolios held by Swiss banks. Since default insurance is not common in Switzerland, the corresponding risks are a severe threat to the health of the financial system. We focus on the analysis of portfolios of residential mortgages and model the probability distribution of the number of defaults using a non-parametric approach, where the intensity processes associated with the time-to-default are linked to a set of predictors through general smooth functions. A generalized additive model is used to condition default intensities of mortgages on relevant economic risk drivers. We calibrate our model on a large mortgage servicing data set and compare the resulting loss distributions to a well-known benchmark – the loss distribution obtained from CreditRisk+ as commonly applied in the industry. The conditional loss distribution and risk measures for a large mortgage portfolio are shown to be highly sensitive to the prevailing socioeconomic conditions.

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