New Definition of Default—Recalibration of Credit Risk Models Using Bayesian Approach

After the financial crisis, the European Banking Authority (EBA) has established tighter standards around the definition of default (Capital Requirements Regulation CRR Article 178, EBA/GL/2017/16) to increase the degree of comparability and consistency in credit risk measurement and capital frameworks across banks and financial institutions. Requirements of the new definition of default (DoD) concern how banks recognize credit defaults for prudential purposes and include quantitative impact analysis and new rules of materiality. In this approach, the number and timing of defaults affect the validity of currently used risk models and processes. The recommendation presented in this paper is to address current gaps by considering a Bayesian approach for PD recalibration based on insights derived from both simulated and empirical data (e.g., a priori and a posteriori distributions). A Bayesian approach was used in two steps: to calculate the Long Run Average (LRA) on both simulated and empirical data and for the final model calibration to the posterior LRA. The Bayesian approach result for the PD LRA was slightly lower than the one calculated based on classical logistic regression. It also decreased for the historically observed LRA that included the most recent empirical data. The Bayesian methodology was used to make the LRA more objective, but it also helps to better align the LRA not only with the empirical data but also with the most recent ones.

Download Full-text

J M Keynes on the Definition of Uncertainty: Why Uncertainty must come in Degrees and has nothing to do with Ergodicity or Non Ergodicity

Scholedge International Journal of Management & Development ISSN 2394-3378 ◽

10.19085/journal.sijmd030101 ◽

2016 ◽

Vol 3 (1) ◽

pp. 1

Author(s):

Michael Emmett Brady

Keyword(s):

A Priori ◽

Quarterly Journal ◽

Decision Makers ◽

Convergence Properties ◽

Academic Field ◽

Long Run ◽

Binary Approach ◽

Short Run ◽

Definition Of ◽

Economic Journal

Keynes’s definition of uncertainty is directly based on his weight of the argument (evidence) relation, analyzed in chapters 6 and 26 of the A Treatise on Probability (1921), page 148,as well as the footnote on page 148 ,of the General Theory (1936) ,and multiple pages of his February, 1937 Quarterly Journal of Economics article. There is no discussion of the definition of Uncertainty in his exchanges with Jan Tinbergen in 1939-40 in the Economic Journal. Paul Davidson and his Post Keynesian-Institutionalist supporters base their Ergodic-Non Ergodic approach to the definitions of uncertainty and risk on the inductive fallacy of Conditional A priorism (Long Runism).The claim , made by Paul Davidson and his Post Keynesian-Institutionalist supporters for over 30 years, that decision makers are able to identify the ergodicity or non ergodicity of long run stochastic sequences or series of events or outcomes in the short run ,based on Davidson’s claim that decision makers are able to know or learn of the convergence properties of such series or sequences, which can only be known “in the long run “(infinity), by examining sub series or sub sequences ,is patently false and not accepted by any scholar in any other academic field . Davidson bases his binary approach to uncertainty, which rules out any concept of different degrees to knowledge (certainty) and unknowledge (uncertainty), on both metaphysical speculations and/or a priori claims to knowledge. There can be no such thing as probable knowledge under this binary approach.

Download Full-text