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RESEARCH PRODUCT

A Discrete-Time Hazard Model for Loans: Some Evidence from Italian Banking System

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Problem statement: The probability of default, PD, is a crucial probl em for banks. In the last years international accords (Basel, Basel 2 an d Basel 3) have incentived banks to adopt objective s systems to evaluating and monitoring risk of defaul t in order to predict PD for new loans based on borrower's characteristics. The aim of this study i s to introduce a discrete survival model to study t he risk of default and to propose the empirical eviden ce by the Italian banking system. Approach: Survival analysis is used if we are interested in w hether and when an event occurs. In this context th e event occurrence represents a borrower's transition from one state, loan in bonis that is not in defau lt, to another state, the default. In this study throug h a survival model (in particular a discrete-time h azard model) it is possible verify when the probability o f default is the highest considering, for each grou p of loans, a set of explanatory variables as risk facto rs of PD. Results: The empirical application obtained through a discrete time hazard model have provided clear evidence that time when the default occurs is an important element to predict the probability of default in time. Regarding Italian data the hazard model shows that explanatory variables (i.e., terr itorial area, productive economic sector, size of l oan and generation of belonging) have effects both on i f and on when loan bankrupts. Conclusion: The hazard model estimated for a population of loans in volve different probability of default considering conjointly the explanatory variables and the time w hen the default occurs. Considering jointly the tim e and the risk factors a probability of default has been modelled for two main groups of loans: "Good borrowers" for which the risk of default is the lowest and "ba d borrowers" for which this risk is the highest.