Credit Risk Modelling: A Literature Overview Based on Market Models

The assessment of businesses' credit risk is a difficult and important process in the area of financial risk management. In a classical multivariate model, financial ratios are combined in order to achieve a credit risk score, which signals if a loan application is approved or discarded. Despite their good performance, the developed multivariate models using statistical methods have been widely criticized. They are based on models that use accounting data, which have the disadvantage of being static and so often fail to follow the changes in the economic and business environment. In recent years, market models (structural and reduced form models) have become popular among banks and financial institutions, because of their theoretical background and the use of updated information. The aim of this article is to present an overview of basic market models (structural models, reduced form models and market models used from credit institutions) together with their characteristics in order to outline their development throughout the last decades.