Credit Models: Looking to the Future

Terry Benzschawel

The previous chapter presented an historical overview of credit models that have gained wide acceptance among practitioners. As discussed, although successful in their various domains, each of those models has limitations. Furthermore, there have been markets for which no satisfactory default risk models have been proposed. These include models for private firms, sovereigns and municipalities. In this chapter, I will describe several approaches that might help to either improve existing methods for estimating firm default risk or offer promise for estimating default risk for previously underserved obligors.

The chapter will begin with consideration of the market-implied default model, based on the measurement of the daily credit risk premium. To the extent that the risk premium, as described below, can be measured in a market, it holds the promise of providing unbiased estimates of default probabilities for any obligor with a short history of market prices. These include private firms, sovereigns and municipalities. This is followed by a discussion of an expert system for measuring sovereign default called the Euromoney credit score, which can be combined with measures of default