A Short Note on Transfer Risk
4 Pages Posted: 11 Mar 2007
Date Written: December 11, 2006
Transfer risk can be an important risk factor for the estimation of a borrower's default risk, and thus has to be included into the PD estimations for the IRB approach under Basel II. In practice, there are two main methodologies for capturing transfer risk: the direct inclusion in the borrower rating system (the country being one of the risk factors, and the country rating often effectively serving as a cap on the rating scale) or the separation of "idiosyncratic borrower default risk" (i.e. borrower default risk ex transfer events) and "transfer risk" into two separate rating systems and two separate PDs. We derive correct PDs that include both borrower and transfer risk and propose a simple methodology to implement the two PDs approach.
Keywords: Transfer risk, PD estimation, conditional probability, Basel II
JEL Classification: C13
Suggested Citation: Suggested Citation