Forecasting Retail Portfolio Credit Risk

A major topic in retail lending is the measurement of the inherent portfolio credit risk. Two importantparameters are default probabilities (PDs) and correlations. Both are considered in theNew Basel Accord. Due to limited empirical evidence on their magnitude, in particular for retailcredit risk, the Basel Committee sets standard specifications for the asset correlations. Using thecharge-off rates filed by all US commercial banks, we estimate in a first step default probabilitiesand asset correlations for the Basel II retail exposure classes and find that the asset correlations ofthe Basel proposal exceed the empirical estimates. The model is then extended by lagged macroeconomicrisk drivers which explain the credit risk of retail exposures given the...