Starting at the Top
Setting Up the Problem
Considering Multiple Vintages
Volatility Analysis and Economic Capital
Credit Scores and Account Management
Analysis of the US Mortgage Crisis
An Example Using [email protected] Data
Examples of Modelling Vintages
Epilogue: it’s about time
Any scenario-based forecasting model can be used to measure volatility or economic capital. Rather than testing a few economic scenarios, as is done in stress testing, we need to create the full range of possible scenarios. When those scenarios are fed through the forecasting model, the distribution of possible futures is created.
This assumes that a functioning, well-validated forecast model is in place before beginning the next step of building a model to generate environmental scenarios. What we cannot do is take a poor forecasting model and attempt to build an economic capital model on top of it. If the capital model does not produce good forecasts for common scenarios, it cannot be considered reliable under extreme scenarios.
Under the Basel II framework (BCBS 2005), risk and capital are thought of as being split into four distinct categories:
For retail loan portfolios, credit risk refers to loan defaults due to a failure to repay on the part of consumers. Market risk is only an issue in securitised pools where mark-to-market assessments can show trading book losses. Operationa