Abstract
This paper addresses the estimation of default probabilities and associated
confidence sets with special focus on rare events. Research on rating transition data has documented a tendency for recently downgraded issuers to
be at an increased risk of experiencing further downgrades compared to issuers that have held the same rating for a longer period of time. To capture
this non-Markov effect we introduce a continuous-time hidden Markov chain
model in which downgrades firms enter into a hidden, ’excited’ state. Using
data from Moody’s we estimate the parameters of the model, and conclude
that both default probabilities and confidence sets are strongly influenced by
the introduction of hidden excited states.
confidence sets with special focus on rare events. Research on rating transition data has documented a tendency for recently downgraded issuers to
be at an increased risk of experiencing further downgrades compared to issuers that have held the same rating for a longer period of time. To capture
this non-Markov effect we introduce a continuous-time hidden Markov chain
model in which downgrades firms enter into a hidden, ’excited’ state. Using
data from Moody’s we estimate the parameters of the model, and conclude
that both default probabilities and confidence sets are strongly influenced by
the introduction of hidden excited states.
| Original language | English |
|---|---|
| Number of pages | 37 |
| Publication status | Published - 2004 |