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Dynamic Default Rates

by Robert Lamb of Imperial College London, and
William Perraudin of Imperial College London

May 2008

Abstract: This paper develops new, dynamic and conditional versions of Vasicek's widely used single factor, default rate distribution. We employ our new class of distributions in modelling US bank loan losses. We analyze the implications for risk, capital, diversification and cyclical effects in loan portfolios and investigate how observed macroeconomic factors such as shocks to industrial production and unemployment affect the distribution of credit losses. A strength of our approach is the simplicity with which one may incorporate rich patterns of autocorrelation and dependence on observable factors into default rate distributions.

JEL Classification: G33, E44, G21.

Keywords: Default, Bank loan, Loss distribution, Capital, Stress test.

Previously titled: Dynamic Loan Loss Distributions: Estimation and implications

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