Credit exposure models backtesting for Basel III
The Basel Committee on Banking Supervision has introduced strict regulatory guidance on how to validate and backtest internal model methods for credit exposure. Fabrizio Anfuso, Dimitrios Karyampas and Andreas Nawroth incorporate these guidelines into a comprehensive statistical backtesting framework based on four pillars: risk factors, correlation, portfolio backtesting and capital buffer computation
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A central component of the Basel III document is ‘Sound practices for backtesting' (Basel Committee on Banking Supervision 2010): a summary of regulatory guidance on how to validate and backtest the internal model method (IMM) for credit exposure. Similarly, a series of requirements from Capital Requirements Directive IV (CRD IV), the European equivalent of Basel III, indicate that backtesting and validation are core components of good governance for IMM firms.
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