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10 - A belief-function perspective to credit risk assessments

Published online by Cambridge University Press:  11 June 2010

By
Rajendra P. Srivastava  and
Stewart Jones
Edited by
Stewart Jones  and
David A. Hensher
Stewart Jones
Affiliation:
University of Sydney
David A. Hensher
Affiliation:
University of Sydney
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Summary

Introduction

Risk assessment in any field is a challenging problem whether it deals with assessing the potential loss of personal properties due to flood, the presence of material misstatements or fraud in the financial statements of a company, or assessing the likelihood of firm survival or loan default. There are two important general concepts related to risk assessment. One deals with the potential loss due to the undesirable event, such as loan default or corporate bankruptcy. The other deals with the uncertainty associated with the event, whether the event will occur or will not occur. There are two kinds of uncertainties. One kind arises purely because of the random nature of the event. For random events, there exist stable frequencies in repeated trials under fixed conditions.

For such random events, one can use the knowledge of the stable frequencies to predict the probability of occurrence of the event. For example, tossing a fair coin is purely a random process with stable frequencies in repeated trials where one would expect to get head 50% of the times and tail 50% of the times. This kind of uncertainty has been the subject of several previous chapters in this volume which has dealt with various statistical approaches to modelling default risk and corporate bankruptcy prediction.

The other kind of uncertainty arises because of the lack of knowledge of the true state of nature where we not only lack the knowledge of a stable frequency, but also we lack the means to specify fully the fixed conditions under which repetitions can be performed (Shafer and Srivastava 1990).

Type
Chapter
Information
Advances in Credit Risk Modelling and Corporate Bankruptcy Prediction , pp. 269 - 294
Publisher: Cambridge University Press
Print publication year: 2008

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