A Cyclical Model of Multiple-Horizon Credit Rating Transitions and Default
47 Pages Posted: 14 Jun 2007
Date Written: June 1, 2007
We estimate a model of natural default probabilities conditional on credit ratings and macroeconomic drivers. The output is an issuer-specific expected default rate at variable horizons, which can be combined to form an expected default rate for a given portfolio of rated credits. This permits us, for the first time, to associate an expected default rate with a rating category conditional on the future path of the economy. In fact, the model outputs an entire issuer-specific transition matrix, of which default is only one possible state. The other states include the entire credit rating scale, as well as withdrawal. We are thus able to assign probabilities to the complete future path of a credit rating conditional on the economy.
Keywords: credit cycles, credit ratings, default, duration model, rating transitions
JEL Classification: C15, C41, C60, G29
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