The Essentials of Risk Management, Third Edition, 3rd Edition

11

QUANTITATIVE APPROACHES TO CREDIT PORTFOLIO RISK AND CREDIT MODELING¹

In Chapter 10 we described the traditional way in which rating agencies and large financial institutions rate the credit risk of bonds and corporate loans, using a judgmental approach supported by certain key financial numbers. In this chapter we describe efforts to model and measure credit risk in whole portfolios using statistical and economic tools, including the Merton model, the actuarial approach, reduced-form models, and hybrid models.² We also briefly review scoring models that can be applied to measure the risk of individual private firms, as opposed to publicly traded companies. These models complement, and to a degree compete with, the traditional approaches ...