The probability approach to default probability

Default estimation for low-default portfolios has attracted attention as banks contemplate the requirements of Basel II's internal ratings-based rules. Here, Nicholas Kiefer applies the probability approach to uncertainty and modelling to default probability estimation, and proposes a formal introduction of expert information into quantitative analysis

Estimates of probability of default (PD), loss given default and exposure at default for portfolio segments containing reasonably homogeneous assets are essential for prudent risk management as well as for compliance with Basel II rules for banks using the internal ratings-based (IRB) approach to determine capital requirements (Basel Committee on Banking Supervision, 2004). Estimation of small probabilities has attracted considerable recent attention (see Basel Committee on Banking Supervision