Estimating Probabilities of Default

Samuel Gregory Hanson, Til Schuermann
2004 Social Science Research Network  
We conduct a systematic comparison of confidence intervals around estimated probabilities of default (PD), using several analytical approaches from large-sample theory and bootstrapped small-sample confidence intervals. We do so for two different PD estimation methods-cohort and duration (intensity)-using twenty-two years of credit ratings data. We find that the bootstrapped intervals for the duration-based estimates are surprisingly tight when compared with the more commonly used (asymptotic)
more » ... used (asymptotic) Wald interval. We find that even with these relatively tight confidence intervals, it is impossible to distinguish notch-level PDs for investment grade ratings-for example, a PD AA -from a PD A+ . However, once the speculative grade barrier is crossed, we are able to distinguish quite cleanly notch-level estimated default probabilities. Conditioning on the state of the business cycle helps; it is easier to distinguish adjacent PDs in recessions than in expansions.
doi:10.2139/ssrn.569841 fatcat:r6hmel5665darm3ldvhesivtsu