Challenges on the Validation of PD Models for Low Default Portfolios (LDPs) and Regulatory Policy Implications

Rungporn Roengpitya and Pratabjai Nilla-or
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Rungporn Roengpitya: Bank of Thailand
Pratabjai Nilla-or: Bank of Thailand

No 2012-02, Working Papers from Monetary Policy Group, Bank of Thailand

Abstract: This paper is the first of its kind to compare the probability of default (PD) estimates for low default portfolios (LDPs) from various methods–notably Pluto and Tasche (2006), Van Der Burgt (2007), Benjamin, Cathcart and Ryan (2006) and Roengpitya (2012)–using the historical data of sovereign borrowers from the years 1975-2009. The comparison results give insightful information to bank supervisors and banks regarding the PD model validation and possible underestimation of PD values. We found that the most conservative approaches tend to be that of Pluto and Tasche (2006) and Roengpitya (2012) while Van Der Burgt (2007) seemed to yield the least conservative estimates. Moreover, for prudent supervisory purposes, we suggested that the accuracy ratio (AR) in the Van Der Burgt (2007) CAP curve method should be restricted to be between 40% and 80% to prevent a possible underestimation of credit risk. Finally, we presented the necessary and sufficient conditions to ensure that the rank ordering of PD estimates from Pluto and Tasche (2006)’s most prudent approach is satisfied.

Keywords: Challenges; on; the; Validation; of; PD; Models (search for similar items in EconPapers)
Pages: 42 pages
Date: 2012-02
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Citations: View citations in EconPapers (1)

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