Portfolio risk in automotive finance

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Over the past decades, automotive finance has evolved into a distinct industry, with banks and independent finance companies managing substantial auto loan and lease portfolios. Recently, this sector has faced changes due to maturing markets and increased competition, making it essential for industry players to balance risk and expected returns. In this context, the importance of risk management as a competitive advantage is growing, particularly in accurately assessing portfolio risk. The unique risks associated with automotive portfolios, which differ from conventional banking, present significant challenges. The prevalence of lease exposures and reliance on a single type of collateral link financial risk to the automotive markets. Traditional portfolio models often fall short, particularly in addressing residual value risk, leading to inadequate measurement and pricing of the inherent risks. This gap poses a challenge for risk managers and academics alike. The author addresses this issue by developing an industry-specific portfolio model that integrates the assessment of default, recovery, and residual value risk while considering their interactions at the portfolio level. This model is grounded in empirical research, utilizing data from over 450,000 contracts from a leading global automotive finance player.