Modeling Credit Risk Factors

Abstract

Usually investors must be willing to take risks for their investments. Therefore, they should be adequately compensated. But what is a fair premium for risk compensation ? To answer this question it is essential to determine the key sources of risk. As we are concerned with credit risk, this section is devoted to the identification of credit risk factors. We show the current practice of credit risk factor modeling and present these methodologies within a rigorous mathematical framework.

“While substantial progress has been made in solving various aspects of the credit risk management problem, the development of a consistent framework for managing various sources of credit risk in an integrated way has been slow.”

Scott Aguais and Dan Rosen, 2001

“Credit risk management is being transformed by the use of quantitative portfolio models. These models can depend on parameters that are difficult to quantify, and that change over time.”

Demchak (2000)