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The optimal structure of PD buckets

  • Krink, Thiemo
  • Paterlini, Sandra
  • Resti, Andrea

In designing credit rating systems under the new Basel Accord, considerable effort has been devoted to rating assignment and quantification, while the choice of the optimal bucket structure has received less attention. To fill this gap, we propose two "bucketing" strategies based on constrained optimisation, paying attention to the implications of rating buckets for loan-pricing and adverse selection phenomena. We compare them with some more naïve approaches, based on a sample of about 100,000 European companies. We also analyse the persistence of our performance measures over time, as well as the effect of large exposures being associated with low-PD obligors.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 10 (October)
Pages: 2275-2286

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Handle: RePEc:eee:jbfina:v:32:y:2008:i:10:p:2275-2286
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  1. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
  2. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, 09.
  3. A. Foglia & S. Iannotti & P. Marullo Reedtz, 2001. "The Definition of the Grading Scales in Banks’ Internal Rating Systems," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 30(3), pages 421-456, November.
  4. William F. Treacy & Mark S. Carey, 1998. "Credit risk rating at large U.S. banks," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 897-921.
  5. Paterlini, Sandra & Krink, Thiemo, 2006. "Differential evolution and particle swarm optimisation in partitional clustering," Computational Statistics & Data Analysis, Elsevier, vol. 50(5), pages 1220-1247, March.
  6. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  7. Steven A. Zimmer & Robert N. McCauley, 1990. "Bank cost of capital and international competition," Quarterly Review, Federal Reserve Bank of New York, issue Win, pages 33-59.
  8. Dirk Tasche, 2003. "A traffic lights approach to PD validation," Papers cond-mat/0305038, arXiv.org.
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