Management of Retail Assets in Banking : Credit Migrations and Default Correlations

The growing relative size and increased volatility of retail portfolios areattracting increased attention from banks' risk managers and regulators.The correlation due to the defaults of retail assets over time has been ofconsiderable interest to retail bankers. Default correlation is importantbecause if the correlation is significantly larger than zero, the defaultrisk is larger. This study shows how economically meaningful assumptionscan be used to obtain cross-obligor default correlations using factor modelapproach. The external market risk factors examined here are IIP, YieldRates, Stock Returns, Inflation, Call Money Rates, etc. We test thehypothesis of the significance of default correlation based on the externaleconomic factors on the internal test data of a bank. In our test portfolioof less than 14 months, we conclude that banks should use positivecorrelation between credit migrations of obligors