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Journal of Banking & Finance Vol. 28 No. 11 2004

Confidence sets for continuous-time rating transition probabilities

Jens H. E. Christensen1; Ernst Albin Hansen2,3; David Lando1

1 Copenhagen Business School · 2 Statistics Denmark · 3 University of Copenhagen

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.

DOI
10.1016/j.jbankfin.2004.06.003
Volume
28
Issue
11
Pages
2575-2602
Language
en
Sources
crossref openalex bibtex:phds-export.bib

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