Forecasting probabilities of default and loss rates given default in the presence of selection

This paper offers a joint estimation approach for forecasting probabilities of default and loss rates given default in the presence of selection. The approach accommodates fixed and random risk factors. An empirical analysis identifies bond ratings, borrower characteristics and macroeconomic information as important risk factors. A portfolio‐level analysis finds evidence that common risk measurement approaches may underestimate bank capital by up to 17% relative to the presented model.