A Reverse Engineering Approach to Price Credit Spreads in the Qualitative Rating Process

21 Pages Posted: 26 Jul 2009 Last revised: 27 Jul 2009

See all articles by Giampaolo Gabbi

Giampaolo Gabbi

SDA Bocconi School of Management

Massimo Matthias

University of Siena - Department of Economics

Marco De Lerma

Ernst & Young, Italy

Date Written: July 20, 2009

Abstract

The paper presents a model to estimate qualitative variables to estimate credit spreads. The main purpose of our study was to price loans and verify whether interest rates depend on credit portfolio weights, applying a reverse engineering process. In particular, loans may be priced from credit portfolio composition applying the Sharpe model (1974) originally devoted to expected returns of asset classes. Our overall percentage of default forecast is higher for the unbalanced sample (around 6% higher) even though we believe the balanced sample is more robust. Using a regression tree we showed how to estimate the probability of default for each rating notch. Monotonicity property of PDs appears to be confirmed for both the samples (unbalanced and balanced) we tested. The final output will be the equilibrium portfolio, which depend upon the bank risk aversion.

Keywords: Credit risk, Reverse engineering, Credit spreads, Risk management

JEL Classification: G11, G21

Suggested Citation

Gabbi, Giampaolo and Matthias, Massimo and De Lerma, Marco, A Reverse Engineering Approach to Price Credit Spreads in the Qualitative Rating Process (July 20, 2009). Available at SSRN: https://ssrn.com/abstract=1436560 or http://dx.doi.org/10.2139/ssrn.1436560

Giampaolo Gabbi (Contact Author)

SDA Bocconi School of Management ( email )

Via Bocconi 8
Milan, Milan 20136
Italy

Massimo Matthias

University of Siena - Department of Economics ( email )

Piazza S. Francesco, 7
Siena, I-53100
Italy
3470838769 (Phone)

Marco De Lerma

Ernst & Young, Italy ( email )

Italy

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