Economic and financial context
From the Technical Note on systemic risk analysis and stress testing:
PDs for certain exposure classes such as foreign sovereigns and institutions are calculated for so called “low default portfolios,” and thus macroeconomic variables are typically not very useful to model such defaults. Historical PDs data for the institutions exposure class show little correlation with macroeconomic developments in Japan or key foreign regions included in the macro forecast scenarios (Euro zone, United Kingdom, U.S., Emerging Asia). To overcome this problem, an alternative approach was used: PDs for institution asset class were forecasted using the BuDA methodology. This model projects one-year PDs for up to five years using the same macroeconomic scenarios. In the baseline scenario, it was assumed that PDs would remain constant. BuDA PDs behave very similarly to EDFs. The estimation uses equity prices and risk free rates (3-month Japan Treasury bill rates) as regressors. Both scenarios reveal similar outcomes: in the moderate adverse scenario, the increase in PDs is driven by a decline in equity prices, negative risk free rates (this reduces banks profitability), and in the severe adverse one by a decline in equity prices, a decline in GDP and a flattening of th
An extended version of the Selected Issues Paper was published in the Nov. 2017 issues of Asia-Pacific Financial Markets
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