Aframework for credit risk management models

This section provides a framework in which to understand and evaluate credit risk
management models. We will describe all the components of a complete (or nearly
complete) credit risk model. Figure 10.3 labels the major components of a credit risk
model.
While at present there is no model that can do everything in Figure 10.3, this
description will be a useful reference by which to evaluate all models. As will be seen
below, portfolio models have a small subset of the components depicted in Figure
10.3. Sometimes by limiting itself to particular products or particular applications,
a model is able to either ignore a component or greatly simplify it. Some models
simply settle for an approximately correct answer. More detailed descriptions and
comparisons of some of these models may be found in Gordy (1998), Koyluglu and
Hickman (1998), Lopez and Saidenber (1998), Lentino and Pirzada (1998), Locke
(1998), and Crouhy and Mark (1998).
The general consensus seems to be that we stand to learn much more about credit
risk. We have yet to even scratch the surface in bringing high-powered, mathematical
techniques to bear on these complicated problems. It would be a mistake to settle
for the existing state of the art and believe we cannot improve. Current discussions
should promote original, customized solutions and thereby encourage active credit
risk management.