The Analytics of Risk Model Validation

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The validity of credit risk model validation methods*

George Christodoulakis^†; Stephen Satchell^‡† Manchester Business School and Bank of Greece, Manchester, UK^‡ Trinity College and Faculty of Economics, University of Cambridge, Cambridge, UK

Abstract

In this chapter, we discuss the nature, properties and pitfalls of a number of credit risk model validation methods. We focus on metrics of discriminatory power between sick and healthy loans, their association and their properties as random variables, which may lead to pitfalls in model validation processes. We conclude with a discussion of bootstrap and credit-rating combinations.

1 Introduction

The development of various types of credit risk models has its origins in the pricing of assets and has ...