Stress Testing: The Use and Abuse of Lagged Default Probabilities in “Forbidden” Credit Models

As the Federal Reserve’s 2015 Comprehensive Capital Analysis and Review stress testing exercise moves to its conclusion, a steady stream of well-intended but incorrect models are coming into public view. In particular, many analysts have been using lagged default probabilities as inputs to their 13 quarter stress tests, a modeling strategy that ProfessorsJoshua Angrist and Jorn-Steffen Pischke label “forbidden models” in their classic econometrics text “ Mostly Harmless Econometrics: An Empiricist’s Companion” (2009).

We explain why such models, however well intended, are usually invalid and unacceptable from a model validation point of view using quotes from Angrist and Pischke.

 

Read more at http://www.kamakuraco.com/Blog/tabid/231/EntryId/729/Stress-Testing-The-Use-and-Abuse-of-Lagged-Default-Probabilities-in-Forbidden-Credit-Models.aspx

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The Association of International Wealth Management of India (AIWMI) is a not-for-profit organization and a globally recognized membership association for finance professionals. AIWMI primarily focuses on the broad and strategic role of developing a more robust and forward-looking training infrastructure for the financial services sector and to promote more active industry involvement and collaboration in training and continuing education. AIWMI is offering advanced international certification programs along with a wide variety of high-quality executive education programs. AIWMI programs combine state-of-the-art knowledge and skills with practical experience and insights into the functioning of the financial sector. All AIWMI courses and educational events have an intense and pragmatic curriculum. Participants are exposed to the latest developments within the financial services sector. AIWMI plays a key role in guiding the development of the financial services sector. AIWMI works with key industry participants’ viz. the Government, the Regulators, the Industries/Associations, the Corporate, the Media and the General Public to achieve its objectives. Besides enhancing technical competence and professionalism in the industry, AIWMI organizes events and facilitates discussions to promote best practices in leadership and talent development in the financial sector with an aim to become Asia’s premier center of excellence for financial education.

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