A stressed loss assumption is a calculation of the expected losses on a securitised pool of assets under a hypothetical stressed economic scenario. This is typically done to assess the resilience of the securitisation to adverse economic conditions.
For example, a stressed loss assumption might be used to calculate the expected losses on a securitisation of home loans under a scenario where unemployment rises to 10% and house prices fall by 20%.
Stressed loss assumptions are used in a range of applications in securitisation, including:
- Risk management: Stressed loss assumptions can be used to assess the risk of default on a securitisation and to determine the amount of capital that needs to be held against the securitisation.
- Credit ratings: Stressed loss assumptions are used by credit rating agencies to determine the credit rating of a securitisation.
- Investor due diligence: Stressed loss assumptions can be used by investors to assess the risk of a securitisation before they invest in it.
A stressed loss assumption is sometimes referred to as a "stressed loss estimate" or a "stressed loss projection".
Here are some examples of how stressed loss assumptions are used in securitisation:
- In a securitisation of home loans, the stressed loss assumption might be used to assess the impact of a rise in unemployment on the default rate on the loans.
- In a securitisation of corporate loans, the stressed loss assumption might be used to assess the impact of a recession on the default rate on the loans.
- In a securitisation of asset-backed securities, the stressed loss assumption might be used to assess the impact of a decline in asset prices on the value of the underlying assets.