Murphy Choy

Determination of the performance period

In Uncategorized on June 3, 2011 at 2:41 am

Many people are confused about the determination of the performance period of any credit risk products. Because of this confusion, we have people who seek the simpler way out and started using the 12 months period as defined in Basel II. However, there is more to this than just a simple definition.

Credit cards and personal loans usually have shorter performance period because they are unsecured in nature and that any abusers or defaulters will naturally reveal their true nature in a short period of time given the lack of repercussion or asset loss. However, for mortgage, performance has to be longer because it is an asset and the people are more likely to attempt to defend their home from foreclosure than paying for the credit card outstanding balances.

Given these problems, one will expect that proper measurement of the performance period will be important. So how does one attempt to measure the optimal performance period. Typically, one will plot the bad(or default) rate graph of the portfolio for an extended period of time to determine the optimal mix.

However, this approach also assumes that you have a particular bad definition in mind to work with. This is not the case here. We were looking for the definition and to do that, one has to decide on the performance period. This is a chicken and egg problem.

The methods above describe the traditional method in determining the optimal mix of values. However, it is far too subjective and unstable for use. To ensure proper use, we will examine some analytical techniques to achieve the above two tasks together.   

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