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Checking Default Correlation and Score Correlation in a Breakpoint Model for Rating Classification

Checking Default Correlation and Score Correlation in a Breakpoint Model for Rating Classification Abstract In credit risk, debtors with different creditworthiness are divided into rating classes. One problem is to define the borders of the rating classes. A natural way to estimate these breakpoints from default observations comes out of the field of change point analysis. In order to account for dependency between the debtors, the literature proposes a combination of a breakpoint model with a one-factor model. One finds strongly consistent estimators for the threshold of the rating classes and the corresponding default probabilities, also called risk levels. But an investigation of the inherent model properties is as yet missing. For this reason we derive the default correlation and study its relationship to the model parameters, i.e., the breakpoint, the risk levels, and a new correlation term, named score correlation, appearing in a simulation study. Eventually, we check the magnitude of the score correlation used in the simulation study. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Economic Quality Control de Gruyter

Checking Default Correlation and Score Correlation in a Breakpoint Model for Rating Classification

Economic Quality Control , Volume 31 (1) – Jun 1, 2016

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Publisher
de Gruyter
Copyright
Copyright © 2016 by the
ISSN
0940-5151
eISSN
1869-6147
DOI
10.1515/eqc-2015-0006
Publisher site
See Article on Publisher Site

Abstract

Abstract In credit risk, debtors with different creditworthiness are divided into rating classes. One problem is to define the borders of the rating classes. A natural way to estimate these breakpoints from default observations comes out of the field of change point analysis. In order to account for dependency between the debtors, the literature proposes a combination of a breakpoint model with a one-factor model. One finds strongly consistent estimators for the threshold of the rating classes and the corresponding default probabilities, also called risk levels. But an investigation of the inherent model properties is as yet missing. For this reason we derive the default correlation and study its relationship to the model parameters, i.e., the breakpoint, the risk levels, and a new correlation term, named score correlation, appearing in a simulation study. Eventually, we check the magnitude of the score correlation used in the simulation study.

Journal

Economic Quality Controlde Gruyter

Published: Jun 1, 2016

References