Rating Models and Validation - Oesterreichische Nationalbank

Rating Models and Validation
cannot be employed in artificial neural networks. For this reason, artificial neural
networks can only be used for segments in which a sufficiently large quantity
of data can be supplied for rating model development.
4.2.3 Causal Models
Option Pricing Models
In general, it is only possible to determine the input parameters required for
these models (market value of equity, volatility of assets, etc.) reliably for
exchange-listed companies and financial service providers, as in these cases the market
value of equity and the volatility of assets can be derived from stock prices
with relative ease. Using cash flow (simulation) models and additional modeling
assumptions, the option pricing model can also be suitable for large companies
which prepare balance sheets if a sufficiently long time series of the necessary
balance sheet data is available and cash flows can be calculated reliably on the
basis of planning data. In the case of smaller borrowers, the effort necessary
for (company) valuation is too high and the calculation of parameters is too
uncertain. However, should a bank decide to develop option pricing models
for such rating segments nonetheless, it is necessary to review the calculated
input parameters critically in terms of adequacy.
Cash Flow (Simulation) Models
Cash flow (simulation) models are especially well suited to specialized lending,as
the primary source of funds for repaying the exposure is the income produced
by the assets financed. This means that creditworthiness essentially depends on
the future cash flows arising from the assets. Likewise, cash flow (simulation)
models can be used as a preliminary processing module for option pricing models.
In principle, cash flow (simulation) models can also be used for exchangelisted
companies and in some cases for large companies which prepare balance
sheets.
The decisive factor in the success of a cash flow (simulation) model is the
suitable calculation of future cash flows and discounting factors. If cash flows
are calculated directly on the basis of historical values, it is important to ensure
that the data set used is representative of the credit institution and to review the
forecasting power of the historical data.
5 Developing a Rating Model
In the previous sections, we discussed rating models commonly used in the market
as well as their strengths and weaknesses when applied to specific rating segments.
A modelÕs suitability for a rating segment primarily depends on the data
and information categories required for credit assessment, which were defined
in terms of best business practices in chapter 3.
The fundamental decision to use a specific rating model for a certain rating
segment is followed by the actual development of the rating procedure. This
chapter gives a detailed description of the essential steps in the development
of a rating procedure under the best-practice approach.
The procedure described in this document is based on the development of a
statistical rating model, as such systems involve special requirements regarding
60 Guidelines on Credit Risk Management