Estimating and validating long run probability of default


Conditional entity PDs for scenario tests and through-the-cycle entity PD all have analytical solutions. International Convergence of Capital Measurement and Capital Standards 10 Basel Committee on Banking Supervision (2009). (2007) Common Failings: How Corporate Defaults are Correlated. For validation, we model the point-in-time entity PD for a commercial portfolio, and stress the portfolio default risk by shocking the systematic risk factors. Principles for Sound Stress Testing Practices and Supervision Basel Committee on Banking Supervision (2009). Stress Testing of Financial Systems: An Overview of Issues, Methodologies, and FSAP Experiences, IMF Working Paper, WP/01/88 Breiman, L. Journal of Finance 62 (1), 93-117 Demey, P., Jouanin, J., Roget, C, and Roncalli, T. Maximum likelihood estimate of default correlations, Risk, November 2004 Drehmann, M. Stress tests: Objectives, challenges and modelling choices, Economic Review, 2008: Vol 60 (2), pp. 4 0.20% 5 0.30% LRPD – a measure of the long-term average of the 6 0.45% probability of default (PD) of the borrower over a one- 7 1.00% year horizon, is typically estimated from historical 8 2.00% default rates.9 8.00% 10 13.50% But there are not sufficient internal default data, 11 25.00% especially for low PD risk ratings.



With these Vasicek models, asset correlation and long-run PD for a risk homogenous po...With these Vasicek models, asset correlation and long-run PD for a risk homogenous portfolio both have analytical solutions, longer external time series for market and macroeconomic variables can be included, and the traditional asymptotic maximum likelihood approach can be shown to be equivalent to least square regression, which greatly simplifies parameter estimation. The analytical formula for long-run PD, for example, explicitly quantifies the contribution of uncertainty to an increase of long-run PD. Fitting Nonlinear Mixed Models with the New NLMIXED Procedure. Basel II Validation Webinar: Estimation of Downturn LGD and Long Run Probability of Default Bogie Ozdemir Vice President, Standard & Poors Risk Solutions Peter Miu Assistant Professor of Finance – De Groote School of Business at Mc Master University April 1, 2008 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poors.



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