Enhanced PD-implied ratings by targeting the credit rating migration matrix
A high-quality and granular probability of default (PD) model is on many practical dimensions far superior to any categorical credit rating system. Business adoption of a PD model, however, needs to factor in the long-established business/regulatory conventions built around letter-based credit ratin...
| Main Authors: | , |
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| Format: | Article |
| Language: | English |
| Published: |
KeAi Communications Co., Ltd.
2021-11-01
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| Series: | Journal of Finance and Data Science |
| Subjects: | |
| Online Access: | http://www.sciencedirect.com/science/article/pii/S2405918821000052 |
| _version_ | 1797203140013981696 |
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| author | Jin-Chuan Duan Shuping Li |
| author_facet | Jin-Chuan Duan Shuping Li |
| author_sort | Jin-Chuan Duan |
| collection | DOAJ |
| description | A high-quality and granular probability of default (PD) model is on many practical dimensions far superior to any categorical credit rating system. Business adoption of a PD model, however, needs to factor in the long-established business/regulatory conventions built around letter-based credit ratings. A mapping methodology that converts granular PDs into letter ratings via referencing the historical default experience of some credit rating agency exists in the literature. This paper improves the PD implied rating (PDiR) methodology by targeting the historical credit migration matrix instead of simply default rates. This enhanced PDiR methodology makes it possible to bypass the reliance on arbitrarily extrapolated target default rates for the AAA and AA+ categories, a necessity due to the fact that the historical realized default rates on these two top rating grades are typically zero. |
| first_indexed | 2024-04-24T08:14:35Z |
| format | Article |
| id | doaj.art-0d2bf64f3de54d588916d5516b03e84d |
| institution | Directory Open Access Journal |
| issn | 2405-9188 |
| language | English |
| last_indexed | 2024-04-24T08:14:35Z |
| publishDate | 2021-11-01 |
| publisher | KeAi Communications Co., Ltd. |
| record_format | Article |
| series | Journal of Finance and Data Science |
| spelling | doaj.art-0d2bf64f3de54d588916d5516b03e84d2024-04-17T03:59:01ZengKeAi Communications Co., Ltd.Journal of Finance and Data Science2405-91882021-11-017115125Enhanced PD-implied ratings by targeting the credit rating migration matrixJin-Chuan Duan0Shuping Li1Asian Institute of Digital Finance and NUS Business School, National University of Singapore, Singapore; Corresponding author.Asian Institute of Digital Finance, National University of Singapore, SingaporeA high-quality and granular probability of default (PD) model is on many practical dimensions far superior to any categorical credit rating system. Business adoption of a PD model, however, needs to factor in the long-established business/regulatory conventions built around letter-based credit ratings. A mapping methodology that converts granular PDs into letter ratings via referencing the historical default experience of some credit rating agency exists in the literature. This paper improves the PD implied rating (PDiR) methodology by targeting the historical credit migration matrix instead of simply default rates. This enhanced PDiR methodology makes it possible to bypass the reliance on arbitrarily extrapolated target default rates for the AAA and AA+ categories, a necessity due to the fact that the historical realized default rates on these two top rating grades are typically zero.http://www.sciencedirect.com/science/article/pii/S2405918821000052DefaultOther-exitRating stickinessSequential Monte Carlo |
| spellingShingle | Jin-Chuan Duan Shuping Li Enhanced PD-implied ratings by targeting the credit rating migration matrix Journal of Finance and Data Science Default Other-exit Rating stickiness Sequential Monte Carlo |
| title | Enhanced PD-implied ratings by targeting the credit rating migration matrix |
| title_full | Enhanced PD-implied ratings by targeting the credit rating migration matrix |
| title_fullStr | Enhanced PD-implied ratings by targeting the credit rating migration matrix |
| title_full_unstemmed | Enhanced PD-implied ratings by targeting the credit rating migration matrix |
| title_short | Enhanced PD-implied ratings by targeting the credit rating migration matrix |
| title_sort | enhanced pd implied ratings by targeting the credit rating migration matrix |
| topic | Default Other-exit Rating stickiness Sequential Monte Carlo |
| url | http://www.sciencedirect.com/science/article/pii/S2405918821000052 |
| work_keys_str_mv | AT jinchuanduan enhancedpdimpliedratingsbytargetingthecreditratingmigrationmatrix AT shupingli enhancedpdimpliedratingsbytargetingthecreditratingmigrationmatrix |