Rating Models and Validation - Oesterreichische Nationalbank

The parameters required to calculate the option price (¼ risk premium) are
the duration of the observation period as well as the following: 36
— Economic value of the debt 37
— Economic value of the equity
— Volatility of the assets.
Due to the required data input, the option pricing model cannot even be
considered for applications in retail business. 38 However, generating the data
required to use the option pricing model in the corporate segment is also
not without its problems, for example because the economic value of the company
cannot be estimated realistically on the basis of publicly available information.
For this purpose, in-house planning data are usually required from the
company itself. The companyÕs value can also be calculated using the discounted
cash flow method. For exchange-listed companies, volatility is frequently estimated
on the basis of the stock priceÕs volatility, while reference values specific
to the industry or region are used in the case of unlisted companies.
In practice, the option pricing model has only been implemented to a limited
extent in German-speaking countries, mainly as an instrument of credit
assessment for exchange-listed companies. 39 However, this model is also being
used for unlisted companies as well.
As a credit default on the part of the company is possible at any time during
the observation period (not just at the end), the risk premium and default rates
calculated with a European-style 40 option pricing model are conservatively
interpreted as the lower limits of the risk premium and default rate in practice.
Qualitative company valuation criteria are only included in the option pricing
model to the extent that the market prices used should take this information
(if available to the market participants) into account. Beyond that, the option
pricing model does not cover qualitative criteria. For this reason, the application
of option pricing models should be restricted to larger companies for which
one can assume that the market price reflects qualitative factors sufficiently (cf.
section 4.2.3).
3.3.2 Cash Flow (Simulation) Models
Cash flow (simulation) models are especially well suited to credit assessment for
specialized lending transactions, as creditworthiness in this context depends primarily
on the future cash flows arising from the assets financed. In this case, the
transaction itself (and not a specific borrower) is assessed explicitly, and the
result is therefore referred to as a transaction rating.
Cash flow-based models can also be presented as a variation on option pricing
models in which the economic value of the company is calculated on the
basis of cash flow.
36 The observation period is generally one year, but longer periods are also possible.
37 For more information on the fundamental circular logic of the option pricing model due to the mutual dependence of the market
value of debt and the risk premium as well as the resolution of this problem using an iterative method, see JANSEN, S, Ertragsund
volatilita‹tsgestu‹tzte Kreditwu‹rdigkeitspru‹fung, p. 75 (footnote) and VARNHOLT B., Modernes Kreditrisikomanagement, p.
107 ff. as well as the literature cited there.
38 Cf. SCHIERENBECK, H., Ertragsorientiertes Bankmanagement Vol. 1.
39 Cf. SCHIERENBECK, H., Ertragsorientiertes Bankmanagement Vol. 1.
40 In contrast to an American option, which can be exercised at any time during the option period.
Rating Models and Validation
Guidelines on Credit Risk Management 49