Home Price Risk Dominates Other Factors Driving Public Firm Default Risk

Kamakura Corporation announced Monday that it has completed a major upgrade of Kamakura Risk Information Services that links 40 key macro economic risk factors to the default probabilities of more than 20,000 public firms in 30 countries. The KRIS upgrade shows that home price related risk factors represent the five most significant risk factors of the 40 factors in the study. Real growth in gross domestic product and the U.S. unemployment rate, which are 2 of the 3 macro factors mandated by bank regulators for stress testing at the 19 largest U.S. banks, rank only 14th and 27th on the list of the 40 most significant risk factors. Kamakura reported that interest rate risk, until recently the primary risk focus of U.S. financial institutions, ranked only 18th on the list of the top 40 drivers of corporate default risk globally. Kamakura’s KRIS default probability clients can access these risk factors and related coefficients via the KRIS credit portfolio management service, KRIS-cdo.

“This upgrade of KRIS allows the users of KRIS and Kamakura Risk Manager to do the kind of ‘credit risk CAT scan’ that is necessary to determine the true driving factors of counterparty credit risk across the full range of counterparties,” said Kamakura Corporation president and chief operating officer Warren Sherman. “This tremendously important risk factor capability in KRIS provides completely transparent visibility of how pervasive home price risk and other risk factors are in the corporate portfolios of major financial institutions, investment management firms, and corporations. Without knowing these links, it’s impossible to accurately perform government-mandated stress tests of macro factors, and it’s impossible to accurately simulate loss distributions and timing in a diversified portfolio.”

KRIS credit portfolio management subscribers to KRIS-cdo can invoke the new macro-factor/default probability relationships seamlessly when simulating portfolio performance in the web-based KRIS-cdo service. Similarly, clients licensing the Kamakura Risk Manager system can download these default probability formulas from KRIS for fully compatible use in enterprise wide risk management, spanning credit risk, market risk, asset and liability management, capital allocation, and Basel II capital calculations.

The technology employed by Kamakura is the “reduced form” credit model technology initially published by Kamakura Managing Director Robert Jarrow with Professor Stuart Turnbull in 1995. The macro-factor driven default probability linkage use the KRIS default data base and a concept described on the Kamakura blog as “reduced reduced form” models, because they are even more “reduced” from the main-line KRIS default probability formulas, which have financial ratios, equity return-related factors, and macro economic factors as inputs. The “reduced reduced form” models simulate forward using macro factors and an idiosyncratic risk factor, eliminating the need to simulate financial statements and equity returns for each of the more than 20,000 companies in the KRIS default data base. This enhanced KRIS technology allows clients to clearly measure the degree of diversification of their credit exposure and the sensitivity of that risk to each of these forty global risk factors. KRIS credit portfolio management clients subscribing to KRIS-cdo have complete access to each of the 20,868 statistical relationships that link default probabilities, company by company, to macro factors in the KRIS service. KRIS credit portfolio management subscribers to KRIS-cdo have direct access to the coefficients, t-scores, standard errors of the regressions, and regression accuracy for all 20,868 relationships. The relationships are based on logistic regression as explained on the Kamakura blog on “reduced reduced form” models.

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