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Conditional probability of default methodology

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  • Segoviano, Miguel A.
Abstract
This paper presents the Conditional Probability of Default (CoPoD) methodology for modelling the probabilities of loan defaults (PoDs) by small and medium size enterprises (SMEs) and unlisted firms as functions of identifiable macroeconomic and financial variables. The process of modelling PoDs represents a challenging task, since the time series of PoDs usually contain few observations, thus making ordinary least squares (OLS) estimation imprecise or unfeasible. CoPoD improves the measurement of the impact of macroeconomic variables on PoDs and consequently the measurement of loans’ credit risk through time, thereby making a twofold contribution. First, econometrically, it recovers estimators that show greater robustness than OLS estimators in finite sample settings under the Mean Square Error criterion. Second, economically, on the basis of economic theory and empirical evidence, CoPoD can incorporate a procedure to select a relevant set of macroeconomic explanatory variables that have an impact on the PoDs. We implement CoPoD with information from Norway and Mexico.

Suggested Citation

  • Segoviano, Miguel A., 2006. "Conditional probability of default methodology," LSE Research Online Documents on Economics 24512, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:24512
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    File URL: http://eprints.lse.ac.uk/24512/
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    References listed on IDEAS

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    Cited by:

    1. Segoviano, Miguel A. & Goodhart, Charles, 2009. "Banking stability measures," LSE Research Online Documents on Economics 24416, London School of Economics and Political Science, LSE Library.
    2. Miguel A. Segoviano & Charles Goodhart, 2010. "Distress Dependence and Financial Stability," Working Papers Central Bank of Chile 569, Central Bank of Chile.
    3. International Monetary Fund, 2009. "Cyprus: Financial Sector Assessment Program Update: Technical Note: Measuring Banking Stability in Cyprus," IMF Staff Country Reports 2009/171, International Monetary Fund.
    4. Antonella Foglia, 2009. "Stress Testing Credit Risk: A Survey of Authorities' Aproaches," International Journal of Central Banking, International Journal of Central Banking, vol. 5(3), pages 9-45, September.
    5. Mr. Mark Swinburne & Stéphanie Marie Stolz & Ms. Marina Moretti, 2008. "Stress Testing at the IMF," IMF Working Papers 2008/206, International Monetary Fund.
    6. Heidari , Hadi & Valipour Pasha , Mohammad & Ahmadyan , Azam, 2015. "Shock Dating on Iranian Banking Network's Balance Sheet," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 10(3), pages 123-149, July.

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    • C00 - Mathematical and Quantitative Methods - - General - - - General
    • E00 - Macroeconomics and Monetary Economics - - General - - - General

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