Seminar by Prof Natalie Packham (Berlin School of Economics and Law / Hochschule für Wirtschaft und Recht)
Title: Credit rating migration processes based on economic-state-dependent transition matrices
Abstract: We develop a model for rating migration. The objective is to study rating migration processes and corresponding default rates. It is generally accepted that rating migrations depend on economic factors. We use the theory of time-homogeneous Markov chains to jointly model the rating process and the state of the economy. Although the rating process itself is neither Markovian nor time-homogeneous in general, we show that the sequence of the rating process’ transition matrices converges to a limit. We further analyse the properties of different rating methods, namely point-in-time (PIT) ratings and through-the-cycle (TTC) ratings. Although these rating philosophies have become important from a regulatory perspective, to the best of our knowledge, no formal definition exists yet. We further discuss if and how a rating philosophy can be detected from given rating transition time series.