Credit Risk Measurement and Models: Probability of Default (PD)

Probability of default (PD) is a forward-looking measure that is largely determined by a customer's financial strength and business prospects, as well as its obligations compared with its resources. A credit rating is allocated to customers with similar PDs so as to make it easier to understand and report customer credit risks. Here we discuss the difference between a PD and a credit rating. We describe the process for calculating a PD and determining a credit rating and the issues surrounding the calculation of a PD and the determination of a credit rating.