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The credit rating process and estimation of transition probabilities: a Bayesian approach
journal contribution
posted on 2023-06-09, 20:22 authored by Catalina Stefanescu, Radu TunaruRadu Tunaru, Stuart TurnbullThe Basel II Accord requires banks to establish rigorous statistical procedures for the estimation and validation of default and ratings transition probabilities. This raises great technical challenges when sufficient default data are not available, as is the case for low default portfolios. We develop a new model that describes the typical internal credit rating process used by banks. The model captures patterns of obligor heterogeneity and ratings migration dependence through unobserved systematic macroeconomic shocks. We describe a Bayesian hierarchical framework for model calibration from historical rating transition data, and show how the predictive performance of the model can be assessed, even with sparse event data. Finally, we analyze a rating transition data set from Standard and Poor's during 1981–2007. Our results have implications for the current Basel II policy debate on the magnitude of default probabilities assigned to low risk assets.
History
Publication status
- Published
Journal
Journal of Empirical FinanceISSN
0927-5398Publisher
ElsevierExternal DOI
Issue
2Volume
16Page range
216-234Department affiliated with
- Accounting and Finance Publications
Research groups affiliated with
- Quantitative International Finance Network Publications
Full text available
- No
Peer reviewed?
- Yes
Legacy Posted Date
2020-01-23Usage metrics
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