Estimating Exposure at Default Under the Internal Ratings-Based Approach

Abstract

Under the Basel II advanced IRB (Internal Ratings Based) approach, banks are encouraged to provide internal estimates for all of the risky parameters determining the minimum regulatory capital. While the PD and LGD estimation issue has recently attracted a lot of attention by the credit risk literature, much less consideration has instead been devoted to the EAD and just few articles treat theoretical and operating features in order to support its practical estimation procedure. In this paper, we present a few possible approaches to the EAD estimation that practitioners in this field should be aware of, and the implications derived from its implementation. In addition, results obtained from the described methodologies are shown and analyzed with respect to a wide sample of default positions of a medium-size Italian banking group.

Keywords: Basel 2, Exposure At Default, Credit Conversion Factors

JEL Classification: G21, G24