Kiefer, Nicholas M. (Cornell U and US Department of the Treasury) Larson, C. Erik (Fannie Mae)
Abstract
The measurement of credit quality is at the heart of the models designed to assess the reserves and capital needed to support the risks of both individual credits and portfolios of credit instruments. A popular specification for credit- rating transitions is the simple, time-homogeneous Markov model. While the Markov specification cannot really describe processes in the long run, it may be useful for adequately describing short-run changes in portfolio risk. In this specification, the entire stochastic process can be characterized in terms of estimated transition probabilities. However, the simple homogeneous Markovian transition framework is restrictive. We propose a test of the null hypotheses of time-homogeneity that can be performed on the sorts of data often reported. We apply the tests to 4 data sets, on commercial paper, sovereign debt, municipal bonds and S&P Corporates. The results indicate that commercial paper looks Markovian on a 30-day time scale for up to 6 months; sovereign debt also looks Markovian (perhaps due to a small sample size); municipals are well-modeled by the Markov specification for up to 5 years, but could probably benefit from frequent updating of the estimated transition matrix or from more sophisticated modeling, and S&P Corporate ratings are approximately Markov over 3 transitions but not 4.
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Paper provided by Cornell University, Center for Analytic Economics in its series Working Papers with number
06-10.
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Find related papers by JEL classification: C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Statistical Simulation Methods C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing G12 - Financial Economics - - General Financial Markets - - - Asset Pricing G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
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Gourieroux, C & Monfort, A & Renault, E, 1993.
"Indirect Inference,"
Journal of Applied Econometrics,
John Wiley & Sons, Ltd., vol. 8(S), pages S85-118, Suppl. De.
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Other versions:
Gourieroux, C. & Monfort, A. & Renault, E., 1992.
"Indirect Inference,"
Papers
92.279, Toulouse - GREMAQ.