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Estimation and prediction of credit risk based on rating transition systems

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  • Jinghai Shao
  • Siming Li
  • Yong Li

Abstract

Risk management is an important practice in the banking industry. In this paper we develop a new methodology to estimate and predict the probability of default (PD) based on the rating transition matrices, which relates the rating transition matrices to the macroeconomic variables. Our method can overcome the shortcomings of the framework of Belkin et al. (1998), and is especially useful in predicting the PD and doing stress testing. Simulation is conducted at the end, which shows that our method can provide more accurate estimate than that obtained by the method of Belkin et al. (1998).

Suggested Citation

  • Jinghai Shao & Siming Li & Yong Li, 2016. "Estimation and prediction of credit risk based on rating transition systems," Papers 1607.00448, arXiv.org, revised Mar 2018.
    • Handle: RePEc:arx:papers:1607.00448
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    References listed on IDEAS

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    1. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
    2. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
    3. Bernd Engelmann & Robert Rauhmeier (ed.), 2011. "The Basel II Risk Parameters," Springer Books, Springer, number 978-3-642-16114-8, September.
    4. Wei, Jason Z., 2003. "A multi-factor, credit migration model for sovereign and corporate debts," Journal of International Money and Finance, Elsevier, vol. 22(5), pages 709-735, October.
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    Cited by:

    1. Landini, S. & Uberti, M. & Casellina, S., 2019. "Credit risk migration rates modelling as open systems II: A simulation model and IFRS9-baseline principles," Structural Change and Economic Dynamics, Elsevier, vol. 50(C), pages 175-189.

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