Assessing the Estimation Uncertainty of Default Probabilities
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Assessing the Estimation Uncertainty of Default Probabilities
Credit and Capital Markets – Kredit und Kapital, Vol. 41 (2008), Iss. 2 : pp. 217–238
3 Citations (CrossRef)
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Dr. Jochen Lawrenz, Universität Innsbruck, Institut für Banken und Finanzen, Universitätsstraße 15, A-6020 Innsbruck.
Cited By
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Comment on the Variance in the Paper Entitled ‘Credit Risk Measures and the Estimation Error in the ASRF Model Under the Basel II IRB Approach’ by Simone Casellina, Simone Landini, and Mariacristina Uberti
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Default probability estimation in small samples—with an application to sovereign bonds
Orth, Walter
Quantitative Finance, Vol. 13 (2013), Iss. 12 P.1891
https://doi.org/10.1080/14697688.2013.792436 [Citations: 8] -
Default Probability Estimation in Small Samples - With an Application to Sovereign Bonds
Orth, Walter
SSRN Electronic Journal, Vol. (2011), Iss.
https://doi.org/10.2139/ssrn.1934808 [Citations: 1]
Abstract
Assessing the Estimation Uncertainty of Default Probabilities
The probability of default (PD) is one of the key variables in credit risk management. By using PD estimates as input to pricing and capital requirement calculations, one should be concerned of how good these estimates are. Confidence intervals are thereby a convenient way to assess the range that covers the true, but unknown parameter with a certain confidence probability. In this paper, we discuss the issues occurring in the construction of confidence intervals for a binomial proportion, and assess the magnitude of estimation uncertainty for exemplary but representative credit portfolios. To give an economic meaning to the range of errors, we translate the PD confidence interval into a risk-weight confidence interval by applying the Basel II IRB approach.
The two main conclusions are: (i) The magnitude of estimation uncertainty can be substantial and is economically relevant. (ii) The choice of confidence interval matters and differences between intervals can be large. (JEL G21, C80)