Template-Type: ReDIF-Paper 1.0
Author-Name: Mikael Juselius
Author-X-Name-First: Mikael
Author-X-Name-Last: Juselius
Author-Name: Nikola Tarashev
Author-X-Name-First: Nikola 
Author-X-Name-Last: Tarashev
Title: When uncertainty decouples expected and unexpected losses
Abstract: A parsimonious extension of a well-known portfolio credit-risk model allows us to study a salient stylized fact – abrupt switches between high- and low-loss phases – from a risk-management perspective. As uncertainty about phase switches increases, expected losses decouple from unexpected losses, which reflect a high percentile of the loss distribution. Banks that ignore this decoupling have shortfalls of loss-absorbing resources, which is more detrimental if the portfolio is more diversified within a phase. Likewise, the risk-management benefits of improving phase-switch forecasts increase with diversification. The analysis of these findings leads us to an empirical method for comparing the degree of within-phase default clustering across portfolios.
Length: 36 pages
Creation-Date: 2022-01
File-URL: https://www.bis.org/publ/work995.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work995.htm
File-Format: text/html
Number: 995
Keywords: expected loss provisioning, bank capital, unexpected losses, credit cycles, portfolio credit risk.
Classification-JEL: G21, G28, G32.
Handle: RePEc:bis:biswps:995