EAD Parameter: A stochastic way to model the Credit Conversion Factor

Following the 2007-2008 financial crisis, the banking industry faced an overall strengthening of regulatory requirements, especially in the EU. The main goal being to ensure an adequate level of capitalisation to guarantee financial robustness. Basel II defined a prudential framework where banks are required to hold minimum capital amount to cover all their risks.

Banks are required to precisely estimate their risks – notably credit risk, which account for more than 75% of banks overall RWA – in order to hold an optimal level of capital while respecting regulatory limits.

This white paper aims at estimating credit risk by modelling the Credit Conversion Factor (CCF) parameter related to the Exposure-at-Default (EAD). It has been decided to perform the estimation thanks to stochastic processes instead of usual statistical methodologies (such as classification tree or GLM).