University of Sussex
Browse

File(s) not publicly available

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 Turnbull
The 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 Finance

ISSN

0927-5398

Publisher

Elsevier

Issue

2

Volume

16

Page range

216-234

Department 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

2020-01-23

Usage metrics

    University of Sussex (Publications)

    Categories

    No categories selected

    Exports