In this lecture, we introduce Moody’s KMV model. Another model we can use to estimate the PD of a company under the IRB class.
Moody’s KMV can be used both as a F-IRB and an A-IRB model. In this class we just focus on the F-IRB use, for the computation of PDs (or EDF to be more precise…).

This model can be seen as a derivation of Merton’s model. In fact we will use Merton’s model to describe how the KMV one works in practice.

Being an industry proprietary model, not all the quantities of interest are publicly known. Nevertheless, at the end of this class, you will have a rather complete understanding of the mechanisms behind the model.

The KMV model is the first industry model we will study together.