Credit Risk Modeling

A Workshop (2 days)

Programme Content Flowchart of Credit Risk Analysis

What credit risk involves:

Probability of default

Loss given default

Single vs. portfolio analysis

Correlations of probability of default across debt

Where it is used:

Loan assessment

Pricing debt, rating debt

Estimating credit spreads

Modeling rating transitions

Pricing credit derivatives

Data sources for credit risk analysis in India:

Defaults

Balance sheet

Credit ratings

Bond and Equity price data

Modeling the probability of default

Probit and Logit models

Merton/KMV mode

Estimating the probability of credit card default

Estimating the probability of default for Indian firms

Estimating the Merton model for Indian firms

Pricing credit default swaps

Programme Content (Cont’d) The Probit and Logit models
Introduction to binary choice (default and no default)
models

Estimation of binary choice models

- The Maximum Likelihood procedure
- Goodness of model fit
- Identifying the important factors, the odds ratio
- Predicting the probability of default

Using the Probit model to estimate the probability of

credit card default

Modeling Probability of Default of Firms

Modeling methodology

Selecting the universe of companies and the sample

period

Defining default

Listing the variables that can explain default

- Accounting ratios
- Industry factors
- Audit quality and accounting practices
- Single factor analysis
- Level vs. changes
Standard techniques for choosing the “best set”
of variables
- Classification tables
- The concept of Power Curves
- Application 2: Using the probit model to estimate the
probability of default for Indian firms
- Altman’s Discriminant model
- Altman’s Emerging Market Score model

Class 4 Using R for Credit Risk Analysis – Hands-on

session

An introduction to the power and the simplicity of R,

Using R for estimating binary choice models

Using R for probit

Using R to predict the probability of credit card default

Programme Content (Cont’d) The Merton model / KMV approach
- Analytic framework: Equity as a call option on the
value of the firm

Debt as a put option on the value of the firm

- The Merton model
- Inputs to the Merton model
- What value of debt to use
- What value of volatility to use

The KMV model

- Estimating Distance from Default (DfD)
- Going from DfD to the probability of default
- Going from DfD to credit rating changes
- Estimating the Merton model for some Indian firms

Comparing the performance of the Merton

model with:
- Scores from balance sheet data
- Credit ratings

Hands-on session
- Using R to estimate the Credit Risk Model
- Using R to estimate the Merton model
- Pricing credit default swaps
Taking Stock
- Quiz
- Putting together the data, programs and
estimated models from this course
- Further topics and concluding remarks