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An Empirical Evaluation of Structural Credit Risk Models

by Nikola A Tarashev of the Bank for International Settlements

March 2008

Abstract: This paper evaluates the capacity of five structural credit risk models to forecast default rates. In contrast to previous studies with similar objectives, the paper employs firm-level data and finds that model-based forecasts of default rates tend to be unbiased and to deliver point-in-time errors that are small in both statistical and economic terms. In addition, in and out-of-sample regression analysis reveals that the models account for a significant portion of the variability of credit risk over time but fail to fully reflect its dependence on macroeconomic cycles.

JEL Classification: G33, E44, G28, c13.

Keywords: probability of default, credit risk models, Basel II, macroeconomic factors of credit risk.

Published in: International Journal of Central Banking, Vol.4, No. 1, (March 2008), pp. 1-53.

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