Stochastic modelling of the default rates and recovery rates of a bank loan
Abstract
In this project, the assumption of risk neutral will be applied to estimate jointly the default
probabilities and recovery rate of a bank loan. This is achieved by putting into consideration the
practical differences between loan and bond to modify and extend Merrick's credit risk model on
bonds. Based on the empirical results from a case Bank, we show that high (low) implied default
recovery rate should result jointly in high (low) implied default rate. In addition, the result also
shows that it should be helpful for banks to reduce the credit risk through diversified loan types.
The model can provide a feasible solution for financial institutions needed to adopt internal
rating-based approach under the new Basel Capital Accord.
Sponsorhip
University of NairobiPublisher
School of mathematics