CreditMetrics explained: measuring credit risk (Excel)

How do financial institutions measure credit risk? One of the most common approaches to credit risk measurement is CreditMetrics, that has been routinely used in the industry since 1990s. Today we are investingating the CreditMetrics approach based on a simple example and discussing its advantages and limitations.
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[@NEDLeducation]

You can find the spreadsheets for this video and some additional materials here: drive.google.com/drive/folders/1sP40IW0p0w5IETCgo464uhDFfdyR6rh7 Please consider supporting NEDL on Patreon: www.patreon.com/NEDLeducation

[@bradyh2189]

Hey the google docs are private :/

[@gaclima]

Congratulations. The explanation using spreadsheet democratizes the understanding of models in such way that anyone can understand.

[@NEDLeducation]

Hi Gabriel, and many thanks for such kind words! This is one of the missions this channel had from the very beginning :)

[@eduardoqueiroz-q8s]

Hi. Very good explanation. Do you consider the credit VaR as the variance? How to expand your analisys from 2-bond portfolio to a, lets say, 10 bonds portfolio?

[@surendrabarsode8959]

Very clearly explained and worked out in Excel. It would be interesting if you can explain various methods and calculations of Point in Time PIT PDs versus Through The Cycle TCC PDs as well as linkages between the two. For banks, PIT and TTC PDs are important from the IFRS 9 and Basel regulatory perspective. This will be certainly useful for a larger community of students of finance, banking and risk.

[@plazmafield]

Hope your Christmas, etc. was great sir. Thank you for making these videos, I enjoy learning from them

[@NEDLeducation]

Hi Stephen, happy Christmas and New Year to you, too! Stay tuned for even more videos in 2021 and thanks for staying with NEDL :)

[@gauravgambhir7702]

Amazing video...Thank you so much. Looking forward to watch more of these knowledgeable videos from you sir.

[@NEDLeducation]

Hi Gaurav, many thanks for the feedback and glad you liked the video! More content on risk management will come around this week so stay tuned!

[@georgemathematician1186]

Beautifully done !

[@aslivinschi]

Sava, this is excellent! I was wondering about how do we stress a transition matrix? Let's say incorporating the market default/downgrades of 2008 financial crisis or any other crisis? I guess there is a powerful tool. Looking forward to become a member

[@ryaannn8250]

Thanks for the video! very helpful as always

[@kiris941]

Hi Sava, found this very useful! Usually portfolios are larger than two assets / counterparties.. Do you have any idea how to calculate the joint transition probabilities for, let's say 20 positions?

[@NEDLeducation]

Hi, and glad you liked the video! As for your question, it is usually done by calculating default correlations and relating them to the impact of defaults on bond value. Might do a video on that at some point in the distant future!

[@aslivinschi]

Hi Sava! In the origina Credit metrics document they are talking about the default correlation between sectors, and I do not understand that. How can we avg. realised default correlation between 2 sectors? sounds tricky and apparently, a simple correlation does not work.

[@NEDLeducation]

Hi Alexei, and thanks for the excellent question! There is a proxy CreditMetrics suggests, and it is equal to sigma^2/(mu - mu^2), where mu is the default rate (percentage of obligors defaulting on average), and sigma is the standard deviation of it over the sample years. Alternatively, they also suggest a method that retrieves default correlations from asset return correlations.

[@aslivinschi]

@@NEDLeducation HI SAVA, THANK YOU VERY MUCH. REALLY APPRECIATED.

[@michelleyang7554]

Hi Sir, thanks for your video. How do you get the table by column "rating" and "value"?

[@NEDLeducation]

Hi Michelle, and thanks for the question! This is an example dataset. You can get data on bond prices and their credit ratings from specialised platforms (like Hargreaves Landsdown) and rating agencies (like S&P), respectively. Hope it helps!

[@michelleyang7554]

@@NEDLeducation Thanks!!

[@rameshkannan1075]

Hi sir I.have a doubt in 6.43 once we find how many acc have moved from ccc to D rating. I need to know if we click that cell then all that data should be displayed. Is there any option

[@NEDLeducation]

Hi Ramesh, and thanks for the question! As a drop from CCC to D is three rating downgrades straight, it is very unlikely it would happen within a year, so this is why the data is as it is. Hope it helps!

[@rameshkannan1075]

@@NEDLeducation sir sorry to ask more questions. My question is to find the list of Accounts where credit rating has been changed. In the above transition matrix we can see the number of acc moved from CCC to CC but i need list of Accounts

[@rameshkannan1075]

And your tutorial is very much helpful sir...

[@NEDLeducation]

@@rameshkannan1075 Hi again Ramesh, and thanks for the follow-up question. You can find publicly available datasets of rating changes on rating agencies' websites, here is the link for Fitch as an example, similar disclosure is also provided by S&P and Moody's: www.fitchratings.com/ratings-history-disclosure

[@rameshkannan1075]

@@NEDLeducation sir thank or ur response..