Default Probabilities III

In this lecture we will consider many new topics together.

We will start by introducing CreditMetrics™ by J.P. Morgan Chase.
CreditMetrics is a structural model of default which derives from Merton’s one. But there is a big difference: the default threshold is not given by liabilities, but computed through credit ratings.
Moreover, CreditMetrics not only takes into account the risk of default of a counterparty, but also the deterioration of its creditworthiness.

We will then have a flashback to lecture 2. Do you remember the F-IRB approach?
In that approach, a bank computes the PD of its counterparties and then plug this information into some specific risk-weight functions, in order to obtain the capital requirements.
Ok, now that we know something more about the computation of the probability of default, it is time to see how we can use this information to compute the C-Var, RWA and capital requirements.

Finally, just to have an idea of how an A-IRB model looks like, we will briefly discuss Credit Risk Plus ©, introduced in 1997 by Credit Suisse. This is a rather powerful tool, not belonging to the class of structural models. We will try to understand its very basic features.

This lecture contains: