View Full Version : Actuarial vs. Reduced Form to Credit Risk Modeling

03-26-2007, 05:45 PM
Can anyone explain the differences between the Actuarial and Reduced Form (Intensity Based) Approach listed in the Risk Management book?

03-26-2007, 09:45 PM
Check the table on page 426 of Crouhy.

The two approaches are quite similar:
They both define the risk as default loss only.
They don't use transition matrices (like the Credit Migration approach).
They both have recovery rates as deterministic "loss given default".
They both use conditional probabilities for defaults.

Some differences:
Conditional probabilities:
For the actuarial approach (CreditRisk+) they are a function of common risk factors (default rates/volatilities, exposure, etc).For the reduced form (intensity-based) approach they are a function of macrofactors (the term structure of risk-free interest rates).

Risk drivers:
The risk drivers for the actuarial approach are expected default rates.
The risk drivers for the reduced form approach is the hazard rate (lambda).

Numerical approach:
The actuarial approach is a closed-form analytic approach.
The reduced form approach is a tree-based simulation approach.

Oh, and there is a thread already for Crouhy (http://www.actuarialoutpost.com/actuarial_discussion_forum/showthread.php?t=101211).

03-27-2007, 09:21 AM
That's a very nice rundown of the two.