Credit Risk

Overview

Credit risk refers to the risk that an obligor on a loan defaults on the loan. That is, a loan default is an event where the obligor on a debt, such as a loan mortgage, fails to pay according to the terms of the loan. At such a point, the obligor is judged to be in default.

Default does not necessarily mean that the lender has lost all future payments. The obligor may cure the loan by paying the missed payments. However, institutions will still experience financial consequences as a result of the delayed timing of any payments, plus any accounting loss the institution takes as a result of writing down the loan.

As such, the primary concern of institutions is not modeling defaults per se, but the losses that occur due to a default. Most models will incorporate the following concepts.

• PD - probability of default
• LGD - loss given default
• EAD - exposure at default

Of the three concepts, typically the probability of default is the one that gets the most attention, and as with any concept, there are multiple ways to model it.

Measurement and Modeling

• Rating Agencies - independent commercial entities which build credit rating models and sell the results.
• Accounting for Credit Risk - discusses the accounting treatment of credit risk.
• Credit Risk Models: mathematical models of credit risk and loss.
• Credit Pricing and CVA
• Analyzing Borrowing Firms - methods for analyzing the credit risk of a firm.
• Economics of Credit and Credit Cycles - discusses credit from the perspective of the broader macro-economy.

Instruments and Trading

• Credit Risk Instruments:
• Credit Risk Trading