FIN4811_Chap9 Credit_Risk_modelling .pptx - 1 FIN4811 Risk Management Chapter Nine Credit Risk Modelling Nattanan Bovornsantisuth Credit Risk Nattanan

FIN4811_Chap9 Credit_Risk_modelling .pptx - 1 FIN4811 Risk...

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FIN4811Risk ManagementChapter NineCredit Risk ModellingNattanan Bovornsantisuth1Credit Risk, Nattanan Bovornsantisuth
AgendaCredit SpreadStatistical Model for Credit ScoringAltman Z-scoreCredit Scoring for Retail KMV Model2Credit Risk, Nattanan Bovornsantisuth
Credit Risk ModellingCredit Spread is the excess interest rate that the investors expect for bearing the credit riskFor example, bond yield spread can be estimated as the spread of corporate bond yield over risk free rate or treasury bond yield.Credit Risk, Nattanan Bovornsantisuth3Credit Spread
Credit Risk ModellingFrom this principal, we can estimate PD following this formula.where: s(T) : Credit SpreadR : Recovery RateIf credit spreads are known for a number of different maturities, the term structure of the hazard rate can be bootstrapped (at least approximately)Credit Risk, Nattanan Bovornsantisuth4Credit Spread
Credit Risk ModellingFor example, Suppose that the CDS spread for 3-, 5-, and 10-year instruments is 50, 60, and 100 basis points and the expected recovery rate is 60%.The average hazard rate over three years is approximately 0.005/(1 − 0.6) = 0.0125.The average hazard rate over five years is approximately 0.006/(1 − 0.6) = 0.015.The average hazard rate over five years is approximately 0.01/(1 − 0.6) = 0.025.From this we can estimatethat the average hazard rate between year 3 and year 5 is (5 × 0.015 − 3 × 0.0125)/2 = 0.01875.Credit Risk, Nattanan Bovornsantisuth5Credit Spread
Credit Risk ModellingWe do calculate PD through the expected loss from NPV of bondsSuppose that a five-year corporate bond with a principal of 100 provides a coupon of 6% per annum (paid semiannually) and that the yield on the bond is 7% per annum (with continuous compounding). The yield on a similar risk-free bond is 5% (again with continuous compounding). The yields imply that the price of the corporate bond is 104.09 and the price of the risk-free bond is 95.34. The expected loss from default over the five-year life of the bond is therefore 104.09 – 95.34, or $8.75. For simplicity, we suppose that the unconditional probability of default per year is the same each year and equal to Q. Furthermore, we assume defaults can happen only at times 0.5, 1.5, 2.5, 3.5, and 4.5 years (immediately before coupon payment dates). Risk-free rates are assumed to be 5% (with continuous compounding) for all maturities and the recovery rate is assumed to be 40%.Credit Risk, Nattanan Bovornsantisuth6Credit Spread
Credit Risk ModellingWe do calculate PD through the expected loss from NPV of bondsSuppose that a five-year corporate bond with a principal of 100 provides a coupon of 6% per annum (paid semiannually) and that the yield on the bond is 7% per annum (with continuous compounding). The yield on a similar risk-free bond is 5% (again with continuous compounding). The yields imply that the price of the corporate bond is 104.09 and the price of the risk-free bond is 95.34. The expected loss from default over the five-year life of the

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