Abstract #300257

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JSM 2003 Abstract #300257
Activity Number: 412
Type: Contributed
Date/Time: Wednesday, August 6, 2003 : 2:00 PM to 3:50 PM
Sponsor: Section on Risk Analysis
Abstract - #300257
Title: Simulating Conditional Ratings Transition Matrices for Credit Risk Analysis
Author(s): Mark S. Coleman*+
Companies:
Address: 65 Hillside Ave., Arlington, MA, 02476-5834,
Keywords: credit risk ; copula ; Markov transition simulation ; Markov generator ; economic forecasting
Abstract:

Quantitative methods for evaluating financial credit risk have gained increasing importance the past several years. Many common analytical credit risk procedures use simulations based upon historical ratings transition matrices published by the major U.S. debt rating agencies. Often, however, the specific approaches used are too limiting in that the observed historical cross-sectional variation in the Markov transition probabilities is not fully utilized to evaluate the future risk of portfolios of credit instruments. We argue that this variation, which in part is caused by changes in the underlying economic and factors that determine credit behavior, is an important element of the true underlying risk of these securities. Further, existing procedures do not allow for conditioning on economic variables, making it difficult to incorporate the effects of anticipated changes in future economic conditions on credit risk predictions. This paper uses a copula-based approach to generate Monte Carlo simulations of ratings transitions that reflects the underlying variation in credit transition behavior and allows conditioning upon a vector of economic variables.

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