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The impact of downward rating momentum on credit portfolio risk

André Güttler and Peter Raupach ()

No 2008,16, Discussion Paper Series 2: Banking and Financial Studies from Deutsche Bundesbank

Abstract: Rating downgrades are known to make subsequent downgrades more likely. We analyze the impact of this ?downward momentum? on credit portfolio risk. Using S&P ratings from 1996 to 2005, we estimate a transition matrix that is insensitive to and a second matrix that is sensitive to previous downgrades. We then derive differences between the insensitive portfolio Value-at-Risk (VaR) and the momentum-sensitive VaR. We find realistic scenarios where investors who rely on insensitive transition matrices underestimate the VaR by eight percent of the correct value. The result is relevant for risk managers and regulators since banks neglecting the downward rating momentum might hold insufficient capital.

Keywords: Rating drift; Downward momentum; Credit portfolio risk; Value-at-Risk (search for similar items in EconPapers)
JEL-codes: C41 G24 G32 (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-rmg
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