The probability approach to default probabilities

Estimation of probability of default (PD), loss given default and exposure at default for portfolio segments containing reasonably homogeneous assets is 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,