Affiliation:
1. College of Business, City University of Hong Kong, Kowloon Tong, Hong Kong, China
Abstract
This paper considers a hypothetical case in which a bank wants to build a routine climate stress test exercise on residential mortgage loans. The bank has regularly updated the probability of default (PD) and loss given default (LGD) on each residential mortgage loan under the internal-rating-based (IRB) approach of Basel II/III. Additionally, the bank estimates the stressed PD and stressed LGD associated with a predetermined extreme weather event. Using simulation techniques, this paper shows that the loss of the bank’s residential mortgage portfolio can reach a median of around 36% of the portfolio value. This remarkable loss comes from the effects of default correlation and property damage. Banks should pay more attention to such impacts of extreme weather events.
Funder
College of Business Research Enhancement Grant for RAE
Subject
Management, Monitoring, Policy and Law,Renewable Energy, Sustainability and the Environment,Geography, Planning and Development,Building and Construction
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