Estimating and validating long run probability of default

To validate the proposed models, we estimate the asset correlations for 13 industry sectors using corporate annual default rates from S&P for years 1981-2011, and long-run PD and asset correlation for a US commercial portfolio, using US delinquent rate for commercial and industry loans from US Federal Reserve.

Keywords: Portfolio level PD; long-run PD; asset correlation; time series; serial correlation; bootstrapping; binomial distribution; maximum likelihood; least square regression; Vasicek model (search for similar items in Econ Papers) JEL-codes: C02 C13 C5 G32 (search for similar items in Econ Papers) New Economics Papers: this item is included in nep-ecm, nep-ore and nep-rmg Date: 2013-07-10 References: View references in Econ Papers View complete reference list from Cit Ec Citations Track citations by RSS feed Downloads: (external link)https://uni-muenchen.de/57244/1/MPRA_paper_57244original version (application/pdf) Related works: This item may be available elsewhere in Econ Papers: Search for items with the same title.

In this paper, we propose a Vasicek-type of models for estimating portfolio level probability of default (PD).

With these Vasicek models, asset correlation and long-run PD for a risk homogenous portfolio both have analytical solutions, longer external time series for market and macroeconomic variables can be included, and the traditional asymptotic maximum likelihood approach can be shown to be equivalent to least square regression, which greatly simplifies parameter estimation.

The analytical formula for long-run PD, for example, explicitly quantifies the contribution of uncertainty to an increase of long-run PD. Fitting Nonlinear Mixed Models with the New NLMIXED Procedure.

We recommend the bootstrap approach to addressing the serial correlation issue for a time series sample.

Journal of Finance, Volume 29 (2), 449-470 [12] Meyer, C. The Journal of Risk Model validation, Volume 2/Number 2, 3-41. Risk quantification of IRB systems at IRB banks: Appendix – A conservative Estimate of a long-term average PD by a hypothetical bank, December 2004 [15] Pindyck, R. Bill Huajian Yang MPRA Paper from University Library of Munich, Germany Abstract: In this paper, we propose a Vasicek-type of models for estimating portfolio level probability of default (PD).With these Vasicek models, asset correlation and long-run PD for a risk homogenous portfolio both have analytical solutions, longer external time series for market and macroeconomic variables can be included, and the traditional asymptotic maximum likelihood approach can be shown to be equivalent to least square regression, which greatly simplifies parameter estimation.The analytical formula for long-run PD, for example, explicitly quantifies the contribution of uncertainty to an increase of long-run PD.

We recommend the bootstrap approach to addressing the serial correlation issue for a time series sample.

Probability of default (PD) is a financial term describing the likelihood of a default over a particular time horizon.

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