Til Schuermann - Academia.edu (original) (raw)

Papers by Til Schuermann

Foundations and Trends in Finance, 2006

In this paper, we provide an overview of the subprime mortgage securitization process and the sev... more In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.

Social Science Research Network, 2004

We conduct a systematic comparison of confidence intervals around estimated probabilities of defa... more We conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD), using several analytical approaches from large-sample theory and bootstrapped small-sample confidence intervals. We do so for two different PD estimation methods-cohort and duration (intensity)-using twenty-two years of credit ratings data. We find that the bootstrapped intervals for the duration-based estimates are surprisingly tight when compared with the more commonly used (asymptotic) Wald interval. We find that even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings-for example, a PD AA-from a PD A+. However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated default probabilities. Conditioning on the state of the business cycle helps; it is easier to distinguish adjacent PDs in recessions than in expansions.

Social Science Research Network, 2005

This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogenei... more This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogeneity in Credit Risk Diversification," presented at the NBER Conference on Risk of Financial Institutions, October 2004. We would like to thank those conference participants, the editors Mark Carey and René Stulz, and our discussant Richard Cantor for helpful and insightful comments. We would also like to thank Yue Chen and Sam Hanson for their excellent research assistance. Any views expressed represent those of the authors only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. Any views expressed represent those of the authors only and not necessarily those of Mercer Oliver Wyman. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

The Journal of Risk Management, Mar 1, 2021

World Scientific Studies in International Economics, Nov 4, 2015

The following sections are included:IntroductionThe Rise of Model Risk Management in BankingModel... more The following sections are included:IntroductionThe Rise of Model Risk Management in BankingModel Risk Management Today …and Going ForwardReferences

Social Science Research Network, 2005

In this paper we conduct a systematic comparison of confidence intervals around estimated probabi... more In this paper we conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD) using several analytical approaches as well as parametric and nonparametric bootstrap methods. We do so for two different PD estimation methods, cohort and duration (intensity), with 22 years of credit ratings data. We find that the bootstrapped intervals for the duration based estimates are relatively tight when compared to either analytic or bootstrapped intervals around the less efficient cohort estimator. We show how the large differences between the point estimates and confidence intervals of these two estimators are consistent with non-Markovian migration behavior. Surprisingly, even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings, e.g. a PD AA-from a PD A+. However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated PDs. Conditioning on the state of the business cycle helps: it is easier to distinguish adjacent PDs in recessions than in expansions.

Handbook of Financial Stress Testing

The Journal of Risk Management, 2016

Abstract: The possibility of exact maximum likelihood estimation of many observation-driven model... more Abstract: The possibility of exact maximum likelihood estimation of many observation-driven models remains an open question. Often only approximate maximum likelihood estimation is attempted, because the unconditional density needed for exact estimation is not known in closed form. Using simulation and nonparametric density estimation techniques that facilitate empirical likelihood evaluation, we develop an exact maximum likelihood procedure. We provide an illustrative application to the estimation of ARCH models, in which we compare the sampling properties of the exact estimator to those of several competitors. We fmd that, especially in situations of small samples and high persistence, efficiency gains are obtained. Acknowledgments: This is a revised and extended version of our earlier paper,

The Journal of Risk Management, 2019

Encyclopedia of Quantitative Finance, 2010

Social Science Research Network, 2005

This paper considers a simple model of credit risk and derives the limit distribution of losses u... more This paper considers a simple model of credit risk and derives the limit distribution of losses under different assumptions regarding the structure of systematic risk and the nature of exposure or firm heterogeneity. We derive fat-tailed correlated loss distributions arising from Gaussian (i.e. non-fat-tailed) risk factors and explore the potential for (and limit of) risk diversification. Where possible the results are generalized to non-Gaussian distributions. The theoretical results indicate that if the firm parameters are heterogeneous but come from a common distribution, for sufficiently large portfolios there is no scope for further risk reduction through active portfolio management. However, if the firm parameters come from different distributions, say for different sectors or countries, then further risk reduction is possible, even asymptotically, by changing the portfolio weights. In either case, neglecting parameter heterogeneity can lead to under estimation of expected losses. But, once expected losses are controlled for, neglecting parameter heterogeneity can lead to over estimation of risk, whether measured by unexpected loss or value-at-risk. We examine the impact of sectoral and geographic diversification on credit losses empirically using returns for firms in the U.S. and Japan across seven sectors and find that ignoring this heterogeneity results in far riskier credit portfolios. Risk, is reduced significantly when parameter heterogeneity is properly taken into account.

Journal of Business & Economic Statistics, Apr 1, 2004

... We fi rst estimate individual country-(or region-)specifi c vector error-correcting models (V... more ... We fi rst estimate individual country-(or region-)specifi c vector error-correcting models (VECMs), where such domes-tic macroeconomic variables as gross domestic product (GDP), the general price level, the level of short-term interest rate, ex-change rate, equity prices (when ...

Cambridge University Press eBooks, Jul 20, 2000

University of Chicago Press eBooks, 2007

This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogenei... more This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogeneity in Credit Risk Diversification," presented at the NBER Conference on Risk of Financial Institutions, October 2004. We would like to thank those conference participants, the editors Mark Carey and René Stulz, and our discussant Richard Cantor for helpful and insightful comments. We would also like to thank Yue Chen and Sam Hanson for their excellent research assistance. Any views expressed represent those of the authors only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. Any views expressed represent those of the authors only and not necessarily those of Mercer Oliver Wyman. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

RePEc: Research Papers in Economics, Jun 1, 2003

We develop a framework for modeling conditional loss distributions through the introduction of ri... more We develop a framework for modeling conditional loss distributions through the introduction of risk factor dynamics. Asset value changes of a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro e.ects to be isolated from idiosyncratic shocks. Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. The model is able to control for firm-specific heterogeneity as well as generate multi-period forecasts of the entire loss distribution, conditional on specific macroeconomic scenarios.

RePEc: Research Papers in Economics, 2008

This paper considers the problem of forecasting real and financial macroeconomic variables across... more This paper considers the problem of forecasting real and financial macroeconomic variables across a large number of countries in the global economy. To this end a global vector autoregressive (GVAR) model previously estimated over the 1979Q1-2003Q4 period by Dees, de Mauro, Pesaran, and Smith (2007), is used to generate out-of-sample one quarter and four quarters ahead forecasts of real output, inflation, real equity prices, exchange rates and interest rates over the period 2004Q1-2005Q4. Forecasts are obtained for 134 variables from 26 regions made up of 33 countries covering about 90% of world output. The forecasts are compared to typical benchmarks: univariate autoregressive and random walk models. Building on the forecast combination literature, the effects of model and estimation uncertainty on forecast outcomes are examined by pooling forecasts obtained from different GVAR models estimated over alternative sample periods. Given the size of the modeling problem, and the heterogeneity of economies considered-industrialised, emerging, and less developed countries-as well as the very real likelihood of possibly multiple structural breaks, averaging forecasts across both models and windows makes a significant difference. Indeed the double-averaged GVAR forecasts performed better than the benchmark competitors, especially for output, inflation and real equity prices.

Social Science Research Network, 2005

In theory the potential for credit risk diversi…cation for banks could be substantial. Portfolios... more In theory the potential for credit risk diversi…cation for banks could be substantial. Portfolios are large enough that idiosyncratic risk is diversi…ed away leaving exposure to systematic risk. The potential for portfolio diversi…cation is driven broadly by two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence individual …rms have to the di¤erent types of risk factors. We propose a model for exploring these dimensions of credit risk diversi…cation: across industry sectors and across di¤erent countries or regions. We …nd that full …rm-level parameter heterogeneity matters a great deal for capturing di¤erences in simulated credit loss distributions. Imposing homogeneity results in overly skewed and fat-tailed loss distributions. These di¤erences become more pronounced in the presence of systematic risk factor shocks: increased parameter heterogeneity greatly reduces shock sensitivity. Allowing for regional parameter heterogeneity seems to better approximate the loss distributions generated by the fully heterogeneous model than allowing just for industry heterogeneity. The regional model also exhibits less shock sensitivity.

We would like to thank participants at the NBER Conference on Risk at Financial Institutions, our... more We would like to thank participants at the NBER Conference on Risk at Financial Institutions, our discussant Randy Kroszner, and Brian Madigan for comments. We also thank Gretchen Weinbach for help with the data and Kristin Wilson for her excellent research assistance. Any views expressed represent those of the authors only, and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. 1. Banks also continue to bear significant credit risk through off-balance sheet guarantees such as standby letters of credit. 106 Evan Gatev, Til Schuermann, and Philip E. Strahan 2. Liquidity risk has been used to justify government deposit insurance (e.g., Diamond and Dybvig, 1983). 3. In a Modigliani-Miller world, holding cash is not costly. However, in a world with taxes, financial distress, or agency costs, holding cash or other liquid assets is costly for banks and other firms (e.g., Myers and Rajan, 1998). Garber and Weisbrod (1990) argue that banks also have an advantage due to their ability to move liquid assets between banks efficiently, thereby lowering the amount of cash that any individual bank needs to hold. 4. Commercial paper often has maturity as short as one week. Firms, however, routinely roll over their paper as it matures.

See, for example, McCarthy (2006), President's Working Group on Financial Markets (2007), and the... more See, for example, McCarthy (2006), President's Working Group on Financial Markets (2007), and the papers in the Banque de France (2007) special issue devoted to hedge funds. In addition to concerns about financial system implications, there are concerns about investor protection and market integrity issues, which we do not discuss.

Foundations and Trends in Finance, 2006

In this paper, we provide an overview of the subprime mortgage securitization process and the sev... more In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.

Social Science Research Network, 2004

We conduct a systematic comparison of confidence intervals around estimated probabilities of defa... more We conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD), using several analytical approaches from large-sample theory and bootstrapped small-sample confidence intervals. We do so for two different PD estimation methods-cohort and duration (intensity)-using twenty-two years of credit ratings data. We find that the bootstrapped intervals for the duration-based estimates are surprisingly tight when compared with the more commonly used (asymptotic) Wald interval. We find that even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings-for example, a PD AA-from a PD A+. However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated default probabilities. Conditioning on the state of the business cycle helps; it is easier to distinguish adjacent PDs in recessions than in expansions.

Social Science Research Network, 2005

This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogenei... more This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogeneity in Credit Risk Diversification," presented at the NBER Conference on Risk of Financial Institutions, October 2004. We would like to thank those conference participants, the editors Mark Carey and René Stulz, and our discussant Richard Cantor for helpful and insightful comments. We would also like to thank Yue Chen and Sam Hanson for their excellent research assistance. Any views expressed represent those of the authors only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. Any views expressed represent those of the authors only and not necessarily those of Mercer Oliver Wyman. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

The Journal of Risk Management, Mar 1, 2021

World Scientific Studies in International Economics, Nov 4, 2015

The following sections are included:IntroductionThe Rise of Model Risk Management in BankingModel... more The following sections are included:IntroductionThe Rise of Model Risk Management in BankingModel Risk Management Today …and Going ForwardReferences

Social Science Research Network, 2005

In this paper we conduct a systematic comparison of confidence intervals around estimated probabi... more In this paper we conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD) using several analytical approaches as well as parametric and nonparametric bootstrap methods. We do so for two different PD estimation methods, cohort and duration (intensity), with 22 years of credit ratings data. We find that the bootstrapped intervals for the duration based estimates are relatively tight when compared to either analytic or bootstrapped intervals around the less efficient cohort estimator. We show how the large differences between the point estimates and confidence intervals of these two estimators are consistent with non-Markovian migration behavior. Surprisingly, even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings, e.g. a PD AA-from a PD A+. However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated PDs. Conditioning on the state of the business cycle helps: it is easier to distinguish adjacent PDs in recessions than in expansions.

Handbook of Financial Stress Testing

The Journal of Risk Management, 2016

Abstract: The possibility of exact maximum likelihood estimation of many observation-driven model... more Abstract: The possibility of exact maximum likelihood estimation of many observation-driven models remains an open question. Often only approximate maximum likelihood estimation is attempted, because the unconditional density needed for exact estimation is not known in closed form. Using simulation and nonparametric density estimation techniques that facilitate empirical likelihood evaluation, we develop an exact maximum likelihood procedure. We provide an illustrative application to the estimation of ARCH models, in which we compare the sampling properties of the exact estimator to those of several competitors. We fmd that, especially in situations of small samples and high persistence, efficiency gains are obtained. Acknowledgments: This is a revised and extended version of our earlier paper,

The Journal of Risk Management, 2019

Encyclopedia of Quantitative Finance, 2010

Social Science Research Network, 2005

This paper considers a simple model of credit risk and derives the limit distribution of losses u... more This paper considers a simple model of credit risk and derives the limit distribution of losses under different assumptions regarding the structure of systematic risk and the nature of exposure or firm heterogeneity. We derive fat-tailed correlated loss distributions arising from Gaussian (i.e. non-fat-tailed) risk factors and explore the potential for (and limit of) risk diversification. Where possible the results are generalized to non-Gaussian distributions. The theoretical results indicate that if the firm parameters are heterogeneous but come from a common distribution, for sufficiently large portfolios there is no scope for further risk reduction through active portfolio management. However, if the firm parameters come from different distributions, say for different sectors or countries, then further risk reduction is possible, even asymptotically, by changing the portfolio weights. In either case, neglecting parameter heterogeneity can lead to under estimation of expected losses. But, once expected losses are controlled for, neglecting parameter heterogeneity can lead to over estimation of risk, whether measured by unexpected loss or value-at-risk. We examine the impact of sectoral and geographic diversification on credit losses empirically using returns for firms in the U.S. and Japan across seven sectors and find that ignoring this heterogeneity results in far riskier credit portfolios. Risk, is reduced significantly when parameter heterogeneity is properly taken into account.

Journal of Business & Economic Statistics, Apr 1, 2004

... We fi rst estimate individual country-(or region-)specifi c vector error-correcting models (V... more ... We fi rst estimate individual country-(or region-)specifi c vector error-correcting models (VECMs), where such domes-tic macroeconomic variables as gross domestic product (GDP), the general price level, the level of short-term interest rate, ex-change rate, equity prices (when ...

Cambridge University Press eBooks, Jul 20, 2000

University of Chicago Press eBooks, 2007

This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogenei... more This is a substantial revision of the paper "The Role of Industry, Geography and Firm Heterogeneity in Credit Risk Diversification," presented at the NBER Conference on Risk of Financial Institutions, October 2004. We would like to thank those conference participants, the editors Mark Carey and René Stulz, and our discussant Richard Cantor for helpful and insightful comments. We would also like to thank Yue Chen and Sam Hanson for their excellent research assistance. Any views expressed represent those of the authors only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. Any views expressed represent those of the authors only and not necessarily those of Mercer Oliver Wyman. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

RePEc: Research Papers in Economics, Jun 1, 2003

We develop a framework for modeling conditional loss distributions through the introduction of ri... more We develop a framework for modeling conditional loss distributions through the introduction of risk factor dynamics. Asset value changes of a credit portfolio are linked to a dynamic global macroeconometric model, allowing macro e.ects to be isolated from idiosyncratic shocks. Default probabilities are driven primarily by how firms are tied to business cycles, both domestic and foreign, and how business cycles are linked across countries. The model is able to control for firm-specific heterogeneity as well as generate multi-period forecasts of the entire loss distribution, conditional on specific macroeconomic scenarios.

RePEc: Research Papers in Economics, 2008

This paper considers the problem of forecasting real and financial macroeconomic variables across... more This paper considers the problem of forecasting real and financial macroeconomic variables across a large number of countries in the global economy. To this end a global vector autoregressive (GVAR) model previously estimated over the 1979Q1-2003Q4 period by Dees, de Mauro, Pesaran, and Smith (2007), is used to generate out-of-sample one quarter and four quarters ahead forecasts of real output, inflation, real equity prices, exchange rates and interest rates over the period 2004Q1-2005Q4. Forecasts are obtained for 134 variables from 26 regions made up of 33 countries covering about 90% of world output. The forecasts are compared to typical benchmarks: univariate autoregressive and random walk models. Building on the forecast combination literature, the effects of model and estimation uncertainty on forecast outcomes are examined by pooling forecasts obtained from different GVAR models estimated over alternative sample periods. Given the size of the modeling problem, and the heterogeneity of economies considered-industrialised, emerging, and less developed countries-as well as the very real likelihood of possibly multiple structural breaks, averaging forecasts across both models and windows makes a significant difference. Indeed the double-averaged GVAR forecasts performed better than the benchmark competitors, especially for output, inflation and real equity prices.

Social Science Research Network, 2005

In theory the potential for credit risk diversi…cation for banks could be substantial. Portfolios... more In theory the potential for credit risk diversi…cation for banks could be substantial. Portfolios are large enough that idiosyncratic risk is diversi…ed away leaving exposure to systematic risk. The potential for portfolio diversi…cation is driven broadly by two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence individual …rms have to the di¤erent types of risk factors. We propose a model for exploring these dimensions of credit risk diversi…cation: across industry sectors and across di¤erent countries or regions. We …nd that full …rm-level parameter heterogeneity matters a great deal for capturing di¤erences in simulated credit loss distributions. Imposing homogeneity results in overly skewed and fat-tailed loss distributions. These di¤erences become more pronounced in the presence of systematic risk factor shocks: increased parameter heterogeneity greatly reduces shock sensitivity. Allowing for regional parameter heterogeneity seems to better approximate the loss distributions generated by the fully heterogeneous model than allowing just for industry heterogeneity. The regional model also exhibits less shock sensitivity.

We would like to thank participants at the NBER Conference on Risk at Financial Institutions, our... more We would like to thank participants at the NBER Conference on Risk at Financial Institutions, our discussant Randy Kroszner, and Brian Madigan for comments. We also thank Gretchen Weinbach for help with the data and Kristin Wilson for her excellent research assistance. Any views expressed represent those of the authors only, and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. 1. Banks also continue to bear significant credit risk through off-balance sheet guarantees such as standby letters of credit. 106 Evan Gatev, Til Schuermann, and Philip E. Strahan 2. Liquidity risk has been used to justify government deposit insurance (e.g., Diamond and Dybvig, 1983). 3. In a Modigliani-Miller world, holding cash is not costly. However, in a world with taxes, financial distress, or agency costs, holding cash or other liquid assets is costly for banks and other firms (e.g., Myers and Rajan, 1998). Garber and Weisbrod (1990) argue that banks also have an advantage due to their ability to move liquid assets between banks efficiently, thereby lowering the amount of cash that any individual bank needs to hold. 4. Commercial paper often has maturity as short as one week. Firms, however, routinely roll over their paper as it matures.

See, for example, McCarthy (2006), President's Working Group on Financial Markets (2007), and the... more See, for example, McCarthy (2006), President's Working Group on Financial Markets (2007), and the papers in the Banque de France (2007) special issue devoted to hedge funds. In addition to concerns about financial system implications, there are concerns about investor protection and market integrity issues, which we do not discuss.