Estimating and Validating Long-Run Probability of Default With Respect to Basel II Requirements

Basel II adopting banks estimate and validate Long-Run Probability of Default (LRPD) for each of their Internal Risk Ratings (IRRs). In this study, we examine alternative methodologies in estimating and validating LRPD. We propose the maximum likelihood estimators incorporating both cross-sectional and serial asset correlations while being consistent with the economic model underlying the Basel II capital requirement formulation. We first adopt …