Modelling default rate in a retail portfolio and the estimation of portfolio risk

Considering correlation as the major driving factor for portfolio risk, Farshad Mashayekhi and Joy Wang present a methodology for the estimation of correlation among retail exposures based on historical default rates in pools of retail accounts. The estimation results can improve the corporate correlation models in portfolio analytics and give a more accurate measure of risk in credit portfolios that include exposures to individuals

Retail exposures, such as residential mortgages, credit cards, auto loans, and student loans make up a large share of credit portfolios in many financial institutions. According to the Federal Deposit Insurance Corporation (FDIC), retail exposures comprised 47% (nearly $2.7 trillion) of all outstanding loans originated by US commercial banks in early 2007 (see figure 1). In addition, these retail exposures make up a large portion of collateral in structured products with about $500 billion

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