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

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

European Journal of Operational Research, 2021, vol. 292, issue 3, 1146-1164

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.

Keywords: Finance; Credit risk modelling; Discrete Markov chains; Lumpability (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:292:y:2021:i:3:p:1146-1164

DOI: 10.1016/j.ejor.2020.11.014

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