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Markov chain lumpability and applications to credit risk modelling in compliance with the International Financial Reporting Standard 9 framework

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  • Georgiou, K.
  • Domazakis, G.N.
  • Pappas, D.
  • Yannacopoulos, A.N.

Abstract

The aim of this paper is threefold. Firstly, we define the necessary quantities associated to the lumpability of a Markov chain and study their fundamental properties. Secondly, we examine the case of approximate lumpability of a non-lumpable Markov and an efficient method of minimizing the error in the approximation. Finally, we introduce a family of general minimization problems that can be approached using this method and examine applications in credit risk modelling, particularly under recent regulatory changes related to loan classification and provision calculations under IFRS 9.

Suggested Citation

  • Georgiou, K. & Domazakis, G.N. & Pappas, D. & Yannacopoulos, A.N., 2021. "Markov chain lumpability and applications to credit risk modelling in compliance with the International Financial Reporting Standard 9 framework," European Journal of Operational Research, Elsevier, vol. 292(3), pages 1146-1164.
    • Handle: RePEc:eee:ejores:v:292:y:2021:i:3:p:1146-1164
    DOI: 10.1016/j.ejor.2020.11.014
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    References listed on IDEAS

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    Cited by:

    1. Tamás Kristóf, 2021. "Sovereign Default Forecasting in the Era of the COVID-19 Crisis," JRFM, MDPI, vol. 14(10), pages 1-24, October.
    2. Kyriakos Georgiou & Athanasios N. Yannacopoulos, 2023. "Probability of Default modelling with L\'evy-driven Ornstein-Uhlenbeck processes and applications in credit risk under the IFRS 9," Papers 2309.12384, arXiv.org.

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