Default Estimation, Correlated Defaults, and Expert Information
AbstractCapital allocation decisions are made on the basis of an assessment of creditworthiness. Default is a rare event for most segments of a bank's portfolio and data information can be minimal. Inference about default rates is essential for efficient capital allocation, for risk management and for compliance with the requirements of the Basel II rules on capital standards for banks. Expert information is crucial in inference about defaults. A Bayesian approach is proposed and illustrated using prior distributions assessed from industry experts. A maximum entropy approach is used to represent expert information. The binomial model, most common in applications, is extended to allow correlated defaults yet remain consistent with Basel II. The application shows that probabilistic information can be elicited from experts and econometric methods can be useful even when data information is sparse.
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Bibliographic InfoPaper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number 08-02.
Date of creation: Apr 2008
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Other versions of this item:
- Nicholas M. Kiefer, 2011. "Default estimation, correlated defaults, and expert information," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(2), pages 173-192, March.
- NEP-ALL-2009-02-07 (All new papers)
- NEP-BAN-2009-02-07 (Banking)
- NEP-ECM-2009-02-07 (Econometrics)
- NEP-RMG-2009-02-07 (Risk Management)
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