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Validation of Credit Default Probabilities via Multiple Testing Procedures

by Sebastian Döhler of the University of Applied Sciences Darmstadt

June 25, 2010

Abstract: We apply multiple testing procedures to the validation of estimated default probabilities in credit rating systems. The goal is to identify rating classes for which the probability of default is estimated inaccurately, while still maintaining a predefined level of committing type I errors as measured by the familywise error rate (FWER) and the false discovery rate (FDR). For FWER, we also consider procedures that take possible discreteness of the data resp. test statistics into account. The performance of these methods is illustrated in a simulation setting and for empirical default data.

AMS Classification: 62P05, 91G40, 62J15.

Keywords: Out-of-sample validation, Credit risk, Multiple test procedures, Familywise error rate, False Discovery rate, Discrete test statistics.

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