Credit Risk Models

This 4-day course reviews credit models as implemented in major financial institutions while pointing to significant improvements made in light of the financial crisis. The course covers four building blocks of credit modelling: Internal credit scoring (rating) models Pricing models for credit derivatives and structured credit products Counterparty risk assessment models based on potential future exposure at default Capital allocation models for credit risk, also known as credit portfolio models For each building block, the course dedicates one full training day. Each block starts with a concept review of the models applied and an assessment on how they fared during the crisis of 2007-2009. Key potential areas of model improvements as well as back / stress testing mechanisms are being discussed in an interactive way. Course participants will be challenged via live case studies to apply their experiences for improving models. The trainer will moderate the discussions while soliciting creative solutions from the participants and will draw conclusions ? which will be compared against industry best practices. Who should attend? The course will be of value to professionals in the following areas: Financial Risk Managers Credit Managers Financial Engineers Financial Industry Regulators Auditors Credit Portfolio Managers Asset Managers
Day 1 Internal rating models Brief overview of the current “sub-prime” triggered financial crisis and the impetus of reviewing credit risk management practices Case study of the “snow-balling effects”. Customer credit rating models A synoptical perspective on internal credit rating models Heuristic / expert models Classic rating questionnaires Qualitative systems Expert systems Fuzzy logic systems Statistical models Multivariate Discriminant Analysis (MVA) – Altman´s Z & ZETA Models Regression models: logit & probit Artificial neural nets Causal models Option pricing models – KMV Credit MonitorTM Cash flow simulation models Hybrid models Models used by rating agencies Requirements for an acceptable credit rating model – auditors Perspective Suitability of credit rating models Examples of rating models used by key industry players Retail customers Corporates Financial institutions Sovereign borrowers Backtesting and validating credit rating models Discriminatory measures Gini coefficient CAP curve ROC Curve AUROC Pietra index Bayesian error rate CIER Index Kolmogorov-Smirnov Test The calibration process Brier score Reliability diagrams Calibration backtesting Management challenges in light of the current crisis Performance review and improvement opportunities – group discussion Day 2 Pricing credit instruments Classical components of credit risk measurement Estimating default probabilities Mathematical underpinning Definition of default / “credit event” (examples & discussion) Marginal vs. Cumulative vs. Average default rates Transition probabilities – properties, examples Actuarial estimating methods Market implied default probabilities – term structure of spreads Case study on bond spreads interpretation Inferring default likelihood from equity prices (Merton model) Recovery rates & LGD Statistical estimates Market implied recovery rates Overview of credit products: Cash products (loans & bonds, incl the syndicated & leveraged loan market) Credit derivative products Credit default swaps First (of basket) to default “NTH” to default CDS indices Total rate of return swaps Credit spread forward options Credit spread options contracts Pricing and hedging credit derivatives Actuarial approach Spread methods Equity pricing methods Examples Modelling default correlations – copula based models Intensity (reduced form) models Structural models (KMV) Factor models Structured credit products Credit linked notes Collateral debt obligations Balance sheet vs. Arbitrage CDOs Cash flow (“funded”) vs. Synthetic CDOs Managed vs static CDOs Market value CDOs Other CDO related structures CDO squared CDS on Abs CDS on CDOs CPDOs (“Constant Proportional Debt Obligations) What went wrong ? (Correlations/ copula instability ; beyond ?) New grounds : migration velocity models ? Day 3 Counterparty risk models Estimating exposure at default Current exposure vs. Potential exposure Estimating potential exposure by instrument type Time profile of expected exposure Case study: expected vs. Maximum exposure for an interest rate swap Case study: exposure profile for an FX swap Exposure modifiers Marking to market (brief discussion on IAS stipulations) Margins Collateral Exposure limits Re-couponing Netting agreements (gross replacement value vs. Net replacement value) ISDAtm master netting agreements Basel II & regulatory recognition Credit triggers Time puts Modelling PFE PFE profile Impact of multi-party netting & collateral (case study) Monte Carlo simulation methods Roll-off risk Collateral models – best practices Mitigating counterparty risk Credit derivatives as hedging instruments Case study for a “wrong way exposure” Collateral hedges Day 4 Portfolio models Credit portfolio models modelling default correlation in portfolio models Deffault vs migration based models Measuring credit VaR Factor models Industry portfolio models Credit metrics TM Creditrisk+TM Moody´s KMVTM Credit portfolio view TM Comparison of industry portfolio models Fitting it all together – RaROC models Integrated risk management – capital allocation The decision process in the credit committee Incremental RaROC Marginal RaROC Regulatory constraints (brief overview of Basel I vs. BaselII) Back to the beginning: what went wrong? Comments on recent market developments: Lehman, Fannie Mae, AIG, etc. Conduit structures SIVs Rating agencies involvements The role of the fed & the regulators Lessons to be learned for risk managers and credit analysts Course summary and close