An Empirical Comparison of Default Risk Forecasts from Alternative Credit Rating Philosophies

International Journal of Forecasting, Vol. 21, No. 1, 2005, pp. 37-51

42 Pages Posted: 10 Nov 2013

Date Written: April 15, 2004

Abstract

The New Basel Capital Accord will allow the determination of banks' regulatory capital requirements due to probabilities of default which are estimated and forecasted from internal ratings. Broadly, two rating philosophies are distinguished: Through the Cycle versus Point in Time Ratings. We employ a Likelihood-Ratio backtesting of both types with respect to their probability of default forecasts and correlations derived from a nonlinear random effects panel model using data from Standard & Poor's. The implications for risk capital using these different philosophies are demonstrated. It is shown that Point in Time Ratings will exhibit much lower correlations and, thus, default probability forecasts should be more precise. As a consequence, Value at Risk quantiles of default distributions should be lower than those generated by Through the Cycle Ratings. Nevertheless banks which use Point in Time Ratings may be punished in times of economic stress if the implied reduction of asset correlation is not taken into account.

Keywords: Credit Rating, Basel II, Backtesting, Risk Management, Credit Risk Modeling

Suggested Citation

Roesch, Daniel, An Empirical Comparison of Default Risk Forecasts from Alternative Credit Rating Philosophies (April 15, 2004). International Journal of Forecasting, Vol. 21, No. 1, 2005, pp. 37-51, Available at SSRN: https://ssrn.com/abstract=2349660

Daniel Roesch (Contact Author)

University of Regensburg ( email )

Chair of Statistics and Risk Management
Faculty of Business, Economics and BIS
Regensburg, 93040
Germany

HOME PAGE: http://www-risk.ur.de/

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
101
Abstract Views
509
rank
292,482
PlumX Metrics