Quantitative Financial Risk Management: Theory and Practice

CHAPTER 12

Predicting Credit Ratings Using a Robust Multicriteria Approach

Constantin Zopounidis

Technical University of Crete, School of Production Engineering, and Management Financial Engineering Laboratory, Audencia Nantes School of Management, France

INTRODUCTION

Credit risk refers to the probability that an obligor will not be able to meet scheduled debt obligations (i.e., default). Credit risk modeling plays a crucial role in financial risk management, in areas such as banking, corporate finance, and investments. Credit risk management has evolved rapidly over the past decades, but the global credit crisis of 2007–2008 highlighted that there is still much to be done at multiple levels. Altman and Saunders (1997) list five main factors that have contributed to the increasing importance of credit risk management:

1. The worldwide increase in the number of bankruptcies
2. The trend toward disintermediation by the highest quality and largest borrowers
3. The increased competition among credit institutions
4. The declining value of real assets and collateral in many markets
5. The growth of new financial instruments with inherent default risk exposure, such as credit derivatives

Early credit risk management was primarily based on empirical evaluation systems. CAMEL has been the most widely used system in this context, which is based on the empirical combination of several factors related to capital, assets, management, earnings, and liquidity. It was soon realized, however, that such empirical ...