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Probability of Default Model to Estimate Ex Ante Credit Risk

Author

Listed:
  • Anna Burova

    (Bank of Russia)

  • Henry Penikas

    (Bank of Russia, Higher School of Economics, Lebedev Physics Institute)

  • Svetlana Popova

    (Bank of Russia)

Abstract

A genuine measure of ex ante credit risk links borrower's financial position with the odds of default. Comprehension of a borrower's financial position is proxied by the derivatives of its filled financial statements, i.e. financial ratios. We identify statistically significant relationships between shortlisted financial ratios and subsequent default events and develop a probability of default (PD) model that assesses the likelihood of a borrower going into delinquency at a one year horizon. We compare the PD model constructed against alternative measures of ex ante credit risk that are widely used in related literature on bank risk taking, i.e. credit quality groups (prudential reserve ratios) assigned to creditors by banks and the credit spreads in interest rates. We find that the PD model predicts default events more accurately at a horizon of one year compared to prudential reserve rates. We conclude that the measure of ex ante credit risk developed is feasible for estimating risk-taking behaviour by banks and analysing shifts in portfolio composition.

Suggested Citation

  • Anna Burova & Henry Penikas & Svetlana Popova, 2021. "Probability of Default Model to Estimate Ex Ante Credit Risk," Russian Journal of Money and Finance, Bank of Russia, vol. 80(3), pages 49-72, September.
    • Handle: RePEc:bkr:journl:v:80:y:2021:i:3:p:49-72
    DOI: 10.31477/rjmf.202103.49
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    Keywords

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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