The relationship between default and economic cycles for retail portfolios across countries

In this paper, we collect consumer delinquency data from several economic shocks in order to study the creation of stress-testing models. We leverage the dual-time dynamics modeling technique to better isolate macroeconomic impacts whenever vintage-level performance data is available. The stress-testing models follow a framework described here of focusing on consumer-centric macroeconomic variables so that the models are as robust as possible when predicting the impacts of future shocks

A common framework for stress testing retail portfolios across countries

In this article, we collect consumer delinquency data from several economic shocks in order to study the creation of stress test models. We leverage the Dual-time Dynamics modeling technique to better isolate macroeconomic impacts whenever vintage-level performance data is available. The stress test models follow a framework described here of focusing on consumer-centric macroeconomic variables so that the models are as robust as possible when predicting the impacts of future shocks. We consider the Mexican Peso Crisis / Tequila Effect by examining Argentina; Asian Economic Crisis by considering Thailand, Indonesia, and Singapore; the Hong Kong SARS recession; and the relative lack of recessions in recent data from Canada and Australia

Stress testing retial loan portfolios with dual-time dynamics

Stress testing has become an important topic in retail lending sincethe introduction of the new Basel II guidelines. The present work uses ascenario-based forecasting approach developed explicitly for retail lendingin order to provide a suitable stress testing approach. We first decomposethe historical vintage performance data into a maturation functionof months-on-books, a quality function of vintage origination date, andan exogenous function of calendar date. In a second step, the exogenousfunction is modeled with macroeconomic data or factors representing portfoliomanagement impacts. Stress tests are performed by extrapolatingthe exogenous function using externally provided scenarios for extrememacroeconomic events. The resulting scenario is combined with the knownmaturation and quality functions. This process is repeated for each of akey set of rates, such as default rate, exposure at default, and loss givendefault in the context of Basel II. These key rate forecasts are combinedto create total portfolio forecasts and stress tests.This approach is demonstrated in an analysis of the US Mortgagemarkets

Stress testing retail load portfolios with dual-time dynamics

Stress testing has become an important topic in retail lending since the introduction of the new Basel II guidelines. The present work uses a scenario-based forecasting approach developed explicitly for retail lending in order to provide a suitable stress testing approach. We first decompose the historical vintage performance data into a maturation function of months-on-books, a quality function of vintage origination date, and an exogenous function of calendar date. In a second step, the exogenous function is modeled with macroeconomic data or factors representing portfolio management impacts. Stress tests are performed by extrapolating the exogenous function using externally provided scenarios for extreme macroeconomic events. The resulting scenario is combined with the known maturation and quality functions. This process is repeated for each of a key set of rates, such as default rate, exposure at default, and loss given default in the context of Basel II. These key rate forecasts are combined to create total portfolio forecasts and stress tests. This approach is demonstrated in an analysis of the US Mortgage markets

Hedging GNMA Mortgage-Backed Securities with T-Note Futures: Dynamic versus Static Hedging

This article proposes a dynamic hedging model for Government National Association Mortgage-Backed Securities (GNMA MBSs) that is free of the drawbacks associated with the static hedging strategies currently used. The simultaneity bias of the regression approach is dealt with by modeling the joint distribution of price changes of GNMA MBSs and 10-year Treasury-note futures. Error correction (EC) terms from cointegrating relationships are included in the conditional mean equations to preserve the long-term equilibrium relationship of the two markets. The time-varying variance-covariance structure of the two markets is modeled via a version of the bivariate generalized autoregressive conditionally heteroskedastic model (bivariate GARCH), which assures that the time-varying variance-covariance matrix is positive semidefinite for all time periods. This dynamic error-correction GARCH model is estimated using daily data on six different coupon GNMA MBSs. Dynamic cross-hedge ratios are obtained from the time-varying variance-covariance matrix using the 10-year Treasury-note futures contract as the hedging instrument. These ratios are evaluated in terms of both overall risk reduction and expected utility maximization. There is overwhelming evidence that dynamic hedge ratios are superior to static ones even when transaction costs are incorporated into the analysis. This conclusion holds for all six different coupon GNMA MBSs under investigation. Copyright American Real Estate and Urban Economics Association.