Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/22456 
Year of Publication: 
2006
Series/Report no.: 
Diskussionsbeitrag No. 344
Publisher: 
Universität Hannover, Wirtschaftswissenschaftliche Fakultät, Hannover
Abstract: 
Lending is associated with credit risk. Modelling the loss stochastically, the cost of credit risk is the expected loss. In credit business the probability that the debtor will default in payments within one year, often is the only reliable quantitative parameter. Modelling the time to default as continuous variable corresponds to an exponential distribution. We calculate the expected loss of a trade with several cash flows, even if the distribution is not exponential. Continuous rating migration data show that the exponential distribution is not adequate in general. The distribution can be calibrated using rating migrations without a parametric model. A practitioner, however, will model time as a discrete variable. We show that the expected loss in the discrete model is a linear approximation of the expected loss in the continuous model and discuss the consequences. Finally, as costs for the expected loss cannot be charged up-front, the credit spread over risk-free interest is derived.
Subjects: 
Point process
credit valuation
hazard rate
kernel smoothing test
JEL: 
C19
C29
Document Type: 
Working Paper

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