Stressed EDF Model Validation At Development (Capital Markets Research)

MODELING METHODOLOGY DECEMBER 2015DECEMBER 2015CAPITAL MARKETS RESEARCHStressed EDFTM Model Validation At DevelopmentSummary¯ Validation of the Stressed EDF (Expected Default Frequency) model shows that the methodological approach and model parameters adequately capture the relationship between macroeconomic factors and the credit risk of public firms.¯ In order to test the out-of-sample validity of the Stressed EDF model methodology, we calculated perfect foresight Stressed EDF measures for the period July 2007 through June 2014 (North America) and July 2011 through June 2014 (North America, Western Europe, Japan, and Australia&New Zealand), conditioned on realized macroeconomic data during this time.¯ In order to test the in-sample validity of the Stressed EDF model methodology, we calculated perfect foresight Stressed EDF measures for longer histories coinciding with each regional models full estimation periods, conditioned on realized macroeconomic data during this time.¯ Both out-of-sample and in-sample perfect foresight Stressed EDF measures conditioned on realized macroeconomic data track (unconditional) EDF measures well at the aggregate and firm levels and within sector.Authors Danielle H. Ferry, PhD +1.212.553.7781 danielle.ferry@moodys.comGlenn Levine +1.212.553.9595 glenn.levine@moodys.comContact Us Americas +1.212.553.1658 clientservices@moodys.comEurope +44.20.7772.5454 clientservices.emea@moodys.comAsia (Excluding Japan) +852.3551.3077 clientservices.asia@moodys.comJapan +81.3 5408.4100 clientservices.japan@moodys.com2 DECEMBER 2015CAPITAL MARKETS RESEARCHTable of Contents1 Introduction 32 Out-of-Sample Perfect Foresight Stressed EDF vs. EDF, by Region and Sector 42.1 North America (July 2007-June 2014) 52.2 North America (July 2011-June 2014) 82.3 Western Europe (July 2011-June 2014) 112.4 Japan (July 2011-June 2014) 142.5 Australia&New Zealand (July 2011-June 2014) 173 In-Sample Perfect Foresight Stressed EDF vs. EDF, by Region and Sector 203.1 North America (January 1986-June 2014) 203.2 Western Europe (January 2000-June 2014) 233.3 Japan (January 1999-June 2014) 263.4 Australia&New Zealand (January 1999-June 2014) 294 In-Sample Perfect Foresight Stressed EDF vs. EDF vs. ODF, Global Rated Firms (January 2000-June 2014) 323 DECEMBER 2015CAPITAL MARKETS RESEARCH1 Introduction Stressed EDF (Expected Default Frequency) measures are one-year default probabilities conditioned on a hypothetical economic scenario. During model development, the Stressed EDF methodology was subjected to in-sample and out-of-sample validation. This paper describes these analyses and presents detailed results. Validation of the Stressed EDF model shows that the methodological approach and model parameters adequately capture the relationship between macroeconomic factors and the credit risk of public firms.Stressed EDF measures...