Modeling the Dynamics of Corporate Credit Ratings: Estimating Ratings Transitions

• Activity Number: 74
• Type: Contributed
• Date/Time: Sunday, August 1, 2010 : 4:00 PM to 5:50 PM
• Sponsor: Business and Economic Statistics Section
• Author(s): Terri Anna Johnson*+ and Meghan Rachel Kent
• Companies: North Carolina State University and North Carolina State University
• Keywords: credit ratings ; macroeconomic ; simulations ; transition matrices ; bonds

Abstract

Over the past few years, corporate creditworthiness has played a critical role in economic decline. Although volatility in the financial market has been described as unprecedented, this raises the question of whether historical patterns of change in creditworthiness still hold, or whether a major shift has occurred. A credit rating transition model can be used to answer this question. A model calibrated to data from Standard and Poor's Performance Report for 1981-2002, and macroeconomic variables on unemployment, interest rates, credit spread, and GDP was used. Transition probabilities predicted by the original model were then compared to credit rating transition histories compiled from the United States Securities and Exchange Commission. Monte Carlo methods were used to determine the probability of rating transitions that actually occurred in the market from 2002 to 2009.