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Credit Risk Measurement Guide

This document provides an introduction to credit risk measurement. It discusses how credit risk arises from instruments sensitive to default, such as corporate debt, sovereign debt, and derivatives. Measuring and managing credit risk is important for risk management and regulatory compliance. Credit events that change the relationship between lender and borrower, such as missed payments, bankruptcy, or distressed debt exchanges, can result in economic losses. Traditional credit risk assessment uses credit ratings, while quantitative models measure credit risk based on spreads, prices of default options, or scoring models. Credit risk can be hedged through loan sales, securitization, or credit derivatives.

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86 views5 pages

Credit Risk Measurement Guide

This document provides an introduction to credit risk measurement. It discusses how credit risk arises from instruments sensitive to default, such as corporate debt, sovereign debt, and derivatives. Measuring and managing credit risk is important for risk management and regulatory compliance. Credit events that change the relationship between lender and borrower, such as missed payments, bankruptcy, or distressed debt exchanges, can result in economic losses. Traditional credit risk assessment uses credit ratings, while quantitative models measure credit risk based on spreads, prices of default options, or scoring models. Credit risk can be hedged through loan sales, securitization, or credit derivatives.

Uploaded by

Pablo Diego
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Introduction to Credit

Risk Measurement

Alberto Plazzi, Financial Intermediation, SP2023, USI


Credit risk: the main issues
• Understanding what determines the value and risk
characteristics of instruments which are sensitive to
default risk (“defaultable”)
− corporate debt
− (some) sovereign debt
− most OTC derivatives
• Why is this a “hot” topic?
− risk management and regulatory rules require that
financial institutions need to include credit risks
− inefficiencies in pricing credit risk can give rise to
profitable opportunities in the market

1
Credit events
• Definition of default is intended to capture events that
change the relationship between lender/bondholder and
borrower/bond issuer from the one which was originally
contracted, and which subjects the lender/bondholder to
an economic loss
• Credit events:
− A missed or delayed disbursement of a contractually-
obligated interest or principal payment (excluding missed
payments cured within a contractually allowed grace
period), as defined in credit agreements and indentures
− A bankruptcy filing or legal receivership by the debt
issuer or obligor that will likely cause a miss or delay in
future contractually-obligated debt service payments

2
Credit events (cont.)
− A distressed exchange whereby (i) an obligor offers
creditors a new or restructured debt, or a new package of
securities, cash or assets that amount to a diminished
financial obligation relative to the original obligation and
(ii) the exchange has the effect of allowing the obligor to
avoid a bankruptcy or payment default in the future
− A change in the payment terms of a credit agreement
or indenture imposed by the sovereign that results in a
diminished financial obligation, such as a forced currency
redenomination (imposed by the debtor, himself, or his
sovereign) or a forced change in some other aspect of the
original promise, such as indexation or maturity

3
Measuring and hedging credit risk
• Traditional “qualitative” approach to assessment of
credit risk based on credit ratings
• Quantitative approaches for measuring credit risk
− Models based on credit spreads
− Models based on option pricing (Merton-KMV)
− Scoring models (Z-score)
• Hedging credit risk
− Loan sales and securitization
− Credit derivatives

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