Forecasting expected and unexpected losses
Juselius, Mikael; Tarashev, Nikola (21.12.2020)
Numero
18/2020Julkaisija
Bank of Finland
2020
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi:bof-202012182575Tiivistelmä
Extending a standard credit-risk model illustrates that a single factor can drive both expected losses and the extent to which they may be exceeded in extreme scenarios, ie “unexpected losses.” This leads us to develop a framework for forecasting these losses jointly. In an application to quarterly US data on loan charge-offs from 1985 to 2019, we find that financial-cycle indicators – notably, the debt service ratio and credit-to-GDP gap – deliver reliable real-time forecasts, signalling turning points up to three years in advance. Provisions and capital that reflect such forecasts would help reduce the procyclicality of banks’ loss-absorbing resources.