Endogenous Derivation and Forecast of Lifetime PDs

16 Pages Posted: 30 Jun 2015 Last revised: 14 Jul 2015

See all articles by Volodymyr Perederiy

Volodymyr Perederiy

European University Viadrina Frankfurt (Oder) - Department of Economics

Date Written: July 14, 2015

Abstract

This paper proposes a simple technical approach for the derivation of future (forward) point-in-time PD forecasts, with minimal data requirements. The inputs required are the current and future through-the-cycle PDs of the obligors, their last known default rates, and a measure for the systematic dependence of the obligors. Technically, the forecasts are made from within a classical asset-based credit portfolio model, just with the assumption of a suitable autoregressive process for the systematic factor. The paper discusses in detail the practical issues of implementation, in particular the parametrization alternatives.

The paper also shows how the approach can be naturally extended to low-default portfolios with volatile default rates, using Bayesian methodology. Furthermore, the expert judgments about the current macroeconomic state, although not necessary for the forecasts, can be embedded using the Bayesian technique.

The presented forward PDs can be used for the derivation of lifetime credit losses required by the new accounting standard IFRS 9. In doing so, the presented approach is endogenous, as it does not require any exogenous macroeconomic forecasts which are notoriously unreliable and often subjective.

Keywords: Prediction, Probability of Default, PD, Default Rates, Through-the-Cycle, TTC, Point-in-Time, PIT, Credit Portfolio Model, Systematic Factor, Macroeconomic Factor, Time Series, Autoregression, Bayesian Analysis, IFRS 9, Accounting, Financial Instruments, Lifetime, Expected Credit Losses

JEL Classification: C13, C11, C22, C51, C53, E32, E37, M41, G33

Suggested Citation

Perederiy, Volodymyr, Endogenous Derivation and Forecast of Lifetime PDs (July 14, 2015). Available at SSRN: https://ssrn.com/abstract=2624761 or http://dx.doi.org/10.2139/ssrn.2624761

Volodymyr Perederiy (Contact Author)

European University Viadrina Frankfurt (Oder) - Department of Economics ( email )

Grosse Scharrnstr. 59
D-15230 Frankfurt (Oder)
Germany

Register to save articles to
your library

Register

Paper statistics

Downloads
243
Abstract Views
643
rank
124,916
PlumX Metrics