Downward migration credit risk problem: a non-homogeneous backward semi-Markov reliability approach

Guglielmo D’Amico, Jacques Janssen and Raimondo Manca
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Guglielmo D’Amico: Università ‘G. d’Annunzio’ di Chieti, Chieti, Italy
Jacques Janssen: Universitè Libre de Bruxelles, Brest, Belgium
Raimondo Manca: Università ‘La Sapienza’, Roma, Italy

Journal of the Operational Research Society, 2016, vol. 67, issue 3, 393-401

Abstract: International organizations evaluate credit risk and rank firms according to risk by assigning them a ‘rating’. The time evolution of a rating can be studied by means of Markov models. Some papers have outlined the problem pertaining to the unsuitable fitting of Markov processes in a credit risk environment. This paper presents a model that overcomes the problems given by the Markov rating models. It includes non-homogeneity, the downward problem and the randomness of time in the transitions of states, thus making it possible to consider the duration inside a state in a complete way. In this paper, both, the transient and asymptotic analyses are presented. The asymptotic analysis is performed by using a mono-unireducible topological structure. Moreover, a real data application is conducted using the historical database of Standard & Poor’s as the source.

Date: 2016
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