This chapter describes the current state of CCR management, modeling and validation as of the early 2020s. Beginning with the historical evolution of counter party credit risk measurement and management, it discusses backtesting and stress testing as applicable to counterparty credit risk.

This chapter focuses on the three types of testing that banks are supposed to conduct for their VaR models. These are conceptual soundness, outcomes analysis and benchmarking. This chapter reviews how these three aspects of validation can be applied to VaR models of banks’ trading activities. In the case of backtesting and benchmarking it demonstrates how banks’ VaR models fare under some the backtesting and benchmarking tests.

This chapter is an overview summarizing relevant established and well-studied distributions for count data that motivate consideration of the Conway–Maxwell–Poisson distribution. Each of the discussed models provides an improved flexibility and computational ability for analyzing count data, yet associated restrictions help readers to appreciate the need for and usefulness of the Conway–Maxwell–Poisson distribution, thus resulting in an explosion of research relating to this model. For completeness of discussion, each of these sections includes discussion of the relevant R packages and their contained functionality to serve as a starting point for forthcoming discussions throughout subsequent chapters. Along with the R discussion, illustrative examples aid readers in understanding distribution qualities and related statistical computational output. This background provides insights regarding the real implications of apparent data dispersion in count data models, and the need to properly address it.

This chapter presents several case studies in the validation of wholesale credit risk models. The steps for each case study include the following: (1) use of the model; (2) internal and external data; (3) model assumptions and methodologies; (4) model performance; (5) outcomes analysis; and (6) the quality and comprehensiveness of development documentation.

A multivariate Poisson distribution is a natural choice for modeling count data stemming from correlated random variables; however, it is limited by the underlying univariate model assumption that the data are equi-dispersed. Alternative models include a multivariate negative binomial and a multivariate generalized Poisson distribution, which themselves suffer from analogous limitations as described in Chapter 1. While the aforementioned distributions motivate the need to instead consider a multivariate analog of the univariate COM–Poisson, such model development varies in order to take into account (or results in) certain distributional qualities. This chapter summarizes such efforts where, for each approach, readers will first learn about any bivariate COM–Poisson distribution formulations, followed by any multivariate analogs. Accordingly, because these models are multidimensional generalizations of the univariate COM–Poisson, they each contain their analogous forms of the Poisson, Bernoulli, and geometric distributions as special cases. The methods discussed in this chapter are the trivariate reduction, compounding, Sarmanov family of distributions, and copulas.

Retail credit risk is an important risk for many banks. This chapter describes various retail credit risk models in great detail and reviews the ways they may be validated. Validation principles are described for models used for risk management, stress testing and other applications. The classes of models include both static scoring models and multi-period loss forecasting models. Within the latter class, roll rate model, vintage-based model, and various other models are described. Account/loan level models are also described, including the Cox Proportional Hazard rate model and multinomial logit model. In each case, the authors discuss the academic underpinnings, the industry usage, and choices that are commonly made under various circumstances. The role of data in determining these choices is also discussed.

This chapter provides a unified discussion of the framework for model validation. It describes how model validation developed over time across various disciplines. It then describes the various approaches that are applied for validation of risk management models at financial institutions.