On a multivariate Markov chain model for credit risk measurement

Tak Kuen Siu, Wai-Ki Ching, S. Eric Fung and Michael Ng

Quantitative Finance, 2005, vol. 5, issue 6, 543-556

Abstract: In this paper, we use credibility theory to estimate credit transition matrices in a multivariate Markov chain model for credit rating. A transition matrix is estimated by a linear combination of the prior estimate of the transition matrix and the empirical transition matrix. These estimates can be easily computed by solving a set of linear programming (LP) problems. The estimation procedure can be implemented easily on Excel spreadsheets without requiring much computational effort and time. The number of parameters is O(s2m2), where s is the dimension of the categorical time series for credit ratings and m is the number of possible credit ratings for a security. Numerical evaluations of credit risk measures based on our model are presented.

Keywords: Correlated credit migrations; Linear programming; Transition matrices; Credibility theory (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (3)

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DOI: 10.1080/14697680500383714

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