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KIC000065

# KIC000065 - Dinan""-to-Default Model Model Default...

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Calibration to an Actual Probability of Default Assume your model outputs a number- this number may be a probabtlltv, butthe probability depends on the distribution assumed in your model It is the case that the observed distributions for models do not match the actual distributions inmodels, so a calibration is needed. _ Need to map the output of the model to an actual probabilitv based on hf,;loric,,1 dat" Vou can use all kinds of ways to map the model output to an actual probability, but a simple way is a binned mapping where you interpolate or smooth between the bins. Moody's KMV uses an empirical mapping of distance- to- default to a probability lEDF = Expected Default Frequency) Example Mapping i-year PD

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Unformatted text preview: Dinan""-to-Default Model Model Default Probabilitv Output Output sa 0.03% ro 0.01% au 0.05% 0.015% zu 0.15% 0.075% sn 0.590 0.35% su 1.0% 0.8% ~ ,."" 1.5% au '.0% '.0% zu 10.Cl% ".0% W 15.tl% 3;.0% 40.ll'II. ;0.0% Reduced Form Models Reduced form models use market prices of debt or spreads to calculate the probability of default. Key differences between structural models:-Default occurs exogenously and not based on a default boundary-Probabilities are risk-neutral You can assume different forms for the probability of default over time.-Constant-A function of time with no random component-Random features with estimated parameters 7...
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