The optimal structure of PD buckets

In designing credit rating systems under the new Basel Accord, considerable effort has been devoted to rating assignment and quantification, while the choice of the optimal bucket structure has received less attention. To fill this gap, we propose two “bucketing” strategies based on constrained opti...

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Bibliographic Details
Published in:Journal of banking & finance 2008-10, Vol.32 (10), p.2275-2286
Main Authors: Krink, Thiemo, Paterlini, Sandra, Resti, Andrea
Format: Article
Language:English
Subjects:
Adverse selection
Basel II
Basel II Internal ratings Probability of default
Credit rating
Credit ratings
Default
Enterprises
Europe
Internal ratings
Loans
Optimization
Pricing
Probability
Probability of default
Regulation of financial institutions
Risk
Structural analysis
Studies
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Summary:In designing credit rating systems under the new Basel Accord, considerable effort has been devoted to rating assignment and quantification, while the choice of the optimal bucket structure has received less attention. To fill this gap, we propose two “bucketing” strategies based on constrained optimisation, paying attention to the implications of rating buckets for loan-pricing and adverse selection phenomena. We compare them with some more naïve approaches, based on a sample of about 100,000 European companies. We also analyse the persistence of our performance measures over time, as well as the effect of large exposures being associated with low-PD obligors.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2007.12.042