A Cyclical Model of Multiple-Horizon Credit Rating Transitions and Default

47 Pages Posted: 14 Jun 2007

Date Written: June 1, 2007

Abstract

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

Suggested Citation

Metz, Albert, A Cyclical Model of Multiple-Horizon Credit Rating Transitions and Default (June 1, 2007). Available at SSRN: https://ssrn.com/abstract=993474 or http://dx.doi.org/10.2139/ssrn.993474

Albert Metz (Contact Author)

The Brattle Group ( email )

44 Brattle Street
3rd Floor
Cambridge, MA 02138-3736
United States

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