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Point-in-Time PD Term Structure Models with Loan Credit Quality as a Component

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  • Yang, Bill Huajian

Abstract

Most point-in-time PD term structure models used in industry for stress testing and IFRS9 expected loss estimation apply only to macroeconomic scenarios. Loan level credit quality is not a factor in these models. In practice, credit profile at assessment time plays an important role in the performance of the loan during its lifetime. A forward-looking point-in-time PD term structure model with loan credit quality as a component is widely expected. In this paper, we propose a forward-looking point-in-time PD term structure model based on forward survival probability, extending the model proposed in [8] by including a loan specific credit quality score as a component. The model can be derived under the Merton model framework. Under this model, the forward survival probability for a forward term is driven by a loan credit quality score in addition to macroeconomic factors. Empirical results show, the inclusion of the loan specific credit score can significantly improve the performance of the model. The proposed approaches provide a tool for modeling point-in-time PD term structure in cases where loan credit profile is essential. The model can be implemented easily by using, for example, the SAS procedure PROC NLMIXED.

Suggested Citation

  • Yang, Bill Huajian, 2017. "Point-in-Time PD Term Structure Models with Loan Credit Quality as a Component," MPRA Paper 80641, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:80641
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    References listed on IDEAS

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    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    2. Rosen, Dan & Saunders, David, 2009. "Analytical methods for hedging systematic credit risk with linear factor portfolios," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 37-52, January.
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    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C40 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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