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Markov chain lumpability and applications to credit risk modelling in compliance with the International Financial Reporting Standard 9 framework

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  • Georgiou, K.
  • Domazakis, G.N.
  • Pappas, D.
  • Yannacopoulos, A.N.

Abstract

The aim of this paper is threefold. Firstly, we define the necessary quantities associated to the lumpability of a Markov chain and study their fundamental properties. Secondly, we examine the case of approximate lumpability of a non-lumpable Markov and an efficient method of minimizing the error in the approximation. Finally, we introduce a family of general minimization problems that can be approached using this method and examine applications in credit risk modelling, particularly under recent regulatory changes related to loan classification and provision calculations under IFRS 9.

Suggested Citation

  • Georgiou, K. & Domazakis, G.N. & Pappas, D. & Yannacopoulos, A.N., 2021. "Markov chain lumpability and applications to credit risk modelling in compliance with the International Financial Reporting Standard 9 framework," European Journal of Operational Research, Elsevier, vol. 292(3), pages 1146-1164.
    • Handle: RePEc:eee:ejores:v:292:y:2021:i:3:p:1146-1164
    DOI: 10.1016/j.ejor.2020.11.014
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    References listed on IDEAS

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    1. Takada, Hideyuki & Sumita, Ushio, 2011. "Credit risk model with contagious default dependencies affected by macro-economic condition," European Journal of Operational Research, Elsevier, vol. 214(2), pages 365-379, October.
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    5. Mojca Gornjak, 2017. "Comparison of IAS 39 and IFRS 9: The Analysis of Replacement," International Journal of Management, Knowledge and Learning, International School for Social and Business Studies, Celje, Slovenia, vol. 6(1), pages 115-130.
    6. Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2006. "Internal ratings systems, implied credit risk and the consistency of banks' risk classification policies," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 1899-1926, July.
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    Cited by:

    1. Tamás Kristóf, 2021. "Sovereign Default Forecasting in the Era of the COVID-19 Crisis," JRFM, MDPI, vol. 14(10), pages 1-24, October.
    2. Kyriakos Georgiou & Athanasios N. Yannacopoulos, 2023. "Probability of Default modelling with L\'evy-driven Ornstein-Uhlenbeck processes and applications in credit risk under the IFRS 9," Papers 2309.12384, arXiv.org.

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