Internal models (IRB) in Basel II: an approach to determining the probability of default

Abstract

The New Accord of Basel, known as Basel II, opens the way for and encourages the implementation of credit entities' own models for measuring their financial risks. In this paper, we focus on the internal models for the assessment of credit risk (IRB), and specifically on the approach to one of their components: the probability of default (PD). Our paper is structured in three sections. In the first section, we present the most significant aspects of the credit risk treatment in Basel II. In the second part, the available financial literature is reviewed. And finally, we undertake an empirical application with the object of determining what is or are the variables that are able to explain why a company defaults. Furthermore, this would serve as a preventive "warning system" for financial entities.