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Credit Risk Measurement Methodologies

by David E. Allen of Edith Cowan University, and
Robert J. Powell of Edith Cowan University

November 2011

Abstract: The significant problems experienced by banks during the Global Financial Crisis have highlighted the critical importance of measuring and providing for credit risk. This paper will examine four popular methods used in the measurement of credit risk and provide an analysis of the relative shortcomings and advantages of each method. The study includes external ratings approaches, financial statement analysis models, the Merton / KMV structural model, and the transition based models of CreditMetrics and CreditPortfolioView. Each model assesses different criteria, and an understanding of the merits and disadvantages of the various models can assist banks and other credit modellers in choosing between the available credit modelling techniques.

Keywords: credit models, credit value at risk, probability of default.

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