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Joint Validation of Credit Rating PDs under Default Correlation

  • Ricardo Schechtman

The Basel Committee on Banking Supervision recognizes that one of the greatest technical challenges to the implementation of the new Basel II Accord lies on the validation of the banks’ internal credit rating models (CRMs). This study investigates new proposals of statistical tests for validating the PDs (probabilities of default) of CRMs. It distinguishes between proposals aimed at checking calibration and those focused at discriminatory power. The proposed tests recognize the existence of default correlation, deal jointly with the default behaviour of all the ratings and, differently to previous literature, control the error of validating incorrect CRMs. Power sensitivity analysis and strategies for power improvement are discussed, providing insights on the trade-offs and limitations pertained to the calibration tests. An alternative goal is proposed for the tests of discriminatory power and results of power dominance are shown for them with direct practical consequences. Finally, as the proposed tests are asymptotic, Monte-Carlo simulations investigate the small sample bias for varying scenarios of parameters.

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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps149.pdf
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Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 149.

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Date of creation: Oct 2007
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Handle: RePEc:bcb:wpaper:149
Contact details of provider: Web page: http://www.bcb.gov.br/?english

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  1. Alan Cosme Rodrigues da Silva & Eduardo Facó Lemgruber & José Alberto Rebello Baranowski & Renato da Silva Carvalho, 2007. "Análise da Coerência de Medidas de Risco no Mercado Brasileiro de Ações e Desenvolvimento de uma Metodologia Híbrida para o Expected Shortfall," Working Papers Series 142, Central Bank of Brazil, Research Department.
  2. Ricardo Schechtman & Valéria Salomão Garcia & Sergio Mikio Koyama & Guilherme Cronemberger Parente, 2004. "Credit Risk Measurement and the Regulation of Bank Capital and Provision Requirements in Brazil - A Corporate Analysis," Working Papers Series 91, Central Bank of Brazil, Research Department.
  3. Fajardo, J. & Farias, A., 2003. "Generalized Hyperbolic Distributions and Brazilian Data," Finance Lab Working Papers flwp_57, Finance Lab, Insper Instituto de Ensino e Pesquisa.
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  6. Vicente, José & Tabak, Benjamin M., 2008. "Forecasting bond yields in the Brazilian fixed income market," International Journal of Forecasting, Elsevier, vol. 24(3), pages 490-497.
  7. Aloisio Araujo & Marcia Leon, 2004. "Speculative Attacks on Debts and Optimum Currency Area: A Welfare Analysis," Working Papers Series 84, Central Bank of Brazil, Research Department.
  8. Pedro H. Albuquerque, 2000. "An Information Theory Approach to the Aggregation of Log-Linear Models," Working Papers Series 4, Central Bank of Brazil, Research Department.
  9. Sergio R. S. Souza & Benjamin M. Tabak & Daniel O. Cajueiro, 2008. "Long-Range Dependence In Exchange Rates: The Case Of The European Monetary System," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(02), pages 199-223.
  10. Araújo, Aloísio Pessoa de & Leon, Márcia Saraiva, 2002. "Speculative Attacks on Debts, Dollarization and Optimum Currency Areas," Economics Working Papers (Ensaios Economicos da EPGE) 446, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  11. Emanuel-Werner Kohlscheen, 2000. "Estimating Exchange Market Pressure and Intervention Activity," Working Papers Series 9, Central Bank of Brazil, Research Department.
  12. Sergio A. Lago Alves & Mirta N. S. Bugarin, 2006. "The Role of Consumer's Risk Aversion on Price Rigidity," Working Papers Series 121, Central Bank of Brazil, Research Department.
  13. Maurício S. Bugarin & Fabia A. de Carvalho, 2005. "Comment on Market Discipline and Monetary Policy by Carl Walsh," Working Papers Series 95, Central Bank of Brazil, Research Department.
  14. Benjamin Miranda Tabak & Solange Maria Guerra, 2002. "Stock Returns and Volatility," Working Papers Series 54, Central Bank of Brazil, Research Department.
  15. Eduardo Lundberg, 2000. "Monetary Policy and Banking Supervision Functions on the Central Bank," Working Papers Series 2, Central Bank of Brazil, Research Department.
  16. Eui Jung Chang & Marcelo Kfoury Muinhos & Joanílio Rodolpho Teixeira, 2002. "Macroeconomic Coordination and Inflation Targeting in a Two-Country Model," Working Papers Series 50, Central Bank of Brazil, Research Department.
  17. Márcio I. Nakane & Leonardo S. Alencar & Fabio Kanczuk, 2006. "Demand for Bank Services and Market Power in Brazilian Banking," Working Papers Series 107, Central Bank of Brazil, Research Department.
  18. Leonardo Soriano de Alencar & Márcio I. Nakane, 2003. "Real Balances in the Utility Function: Evidence for Brazil," Working Papers Series 68, Central Bank of Brazil, Research Department.
  19. Rafael Santos & Aloisio Araujo, 2007. "Inflation Targeting, Credibility and Confidence Crises," Working Papers Series 140, Central Bank of Brazil, Research Department.
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  21. Marcelle Chauvet, 2000. "Leading Indicators of Inflation for Brazil," Working Papers Series 7, Central Bank of Brazil, Research Department.
  22. Ricardo Schechtman, 2006. "Uma Investigação Baseada em Reamostragem sobre Requerimentos de Capital para Risco de Crédito no Brasil," Working Papers Series 127, Central Bank of Brazil, Research Department.
  23. Ryan A. Compton & Jose Ricardo da Costa e Silva, 2005. "Finance and the Business Cycle: a Kalman Filter Approach with Markov Switching," Working Papers Series 97, Central Bank of Brazil, Research Department.
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