The Basel II Risk Parameters: Estimation, Validation, and Stress Testing

A critical problem in the practice of banking risk assessment is the estimation and validation of the Basel II risk parameters PD (default probability), LGD (loss given default), and EAD (exposure at default). This book presents the state-of-the-art in designing and validating rating systems and default probability estimations, and outlines techniques to estimate LGD and EAD. Also included is a chapter on stress testing of the Basel II risk parameters.

The estimation and the validation of the Basel II risk parameters PD (default probability), LGD (loss given fault), and EAD (exposure at default) is an important problem in banking practice. These parameters are used on the one hand as inputs to credit portfolio models and in loan pricing frameworks, on the other to compute regulatory capital according to the new Basel rules. This book covers the state-of-the-art in designing and validating rating systems and default probability estimations. Furthermore, it presents techniques to estimate LGD and EAD and includes a chapter on stress testing of the Basel II risk parameters. The second edition is extended by three chapters explaining how the Basel II risk parameters can be used for building a framework for risk-adjusted pricing and risk management of loans.