Joint Validation of Credit Rating PDs under Default Correlation
by Ricardo Schechtman
Central Bank of Brazil
This study investigates new proposals of statistical tests for
validating the PDs (probabilities of default) of credit rating
models (CRMs). The proposed tests recognize the existence of
default correlation, deal jointly with the default behavior of all
the ratings, and, in contrast to previous literature, control the
error of validating incorrect CRMs. Power-sensitivity analysis
and strategies for power improvement are discussed for the calibration
tests, whereas a non-typical goal is proposed for the
tests of discriminatory power, leading to results of power dominance.
Finally, Monte Carlo simulations investigate the finite
sample bias for varying scenarios of parameters.
JEL Codes: C12, G21, G28.
Full article (PDF, 48 pages, 1,749 kb)