Credit Scoring via Altman Z ‐Score

Abstract During the last several years, assessing the probability of default (PD) and loss give default (LGD) on credit assets have become a high priority task in the internal credit risk systems of the financial institutions. Such an intense surge of interest is caused by the following factors: A historic high in the frequency and severity of bankruptcy at the turn of the century have attracted much media attention. Basel Accord on credit risk capital adequacy—the so‐called Basel II Accord; see Basel Commission on Banking Supervision—for banks and financial institutions to qualify for the advanced internal rating based (IRB) approach, they need to develop better assessment of PD and LGD. To address the enormous need of PD and LGD evaluations, various quantitative techniques have been employed not only by financial institutions, but also regulatory bodies and the rating agencies. In this chapter, a brief review of the techniques of credit scoring in estimating PD is presented. For LGD computations, one can refer to Chapter 15 of Altman and Hotchkiss.