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Estimating rating transition probabilites with missing data

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  • Marco Bee

    (University of Trento)

Abstract

In this article we provide a rigorous treatment of one of the central statistical issues of credit risk management. GivenK-1 rating categories, the rating of a corporate bond over a certain horizon may either stay the same or change to one of the remainingK-2 categories; in addition, it is usually the case that the rating of some bonds is withdrawn during the time interval considered in the analysis. When estimating transition probabilities, we have thus to consider aK-th category, called withdrawal, which contains (partially) missing data. We show how maximum likelihood estimation can be performed in this setup; whereas in discrete time our solution gives rigorous support to a solution often used in applications, in continuous time the maximum likelihood estimator of the transition matrix computed by means of the EM algorithm represents a significant improvement over existing methods.

Suggested Citation

  • Marco Bee, 2005. "Estimating rating transition probabilites with missing data," Statistical Methods & Applications, Springer;Società Italiana di Statistica, vol. 14(1), pages 127-141, February.
    • Handle: RePEc:spr:stmapp:v:14:y:2005:i:1:d:10.1007_bf02511578
    DOI: 10.1007/BF02511578
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    References listed on IDEAS

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    1. Lando, David & Skodeberg, Torben M., 2002. "Analyzing rating transitions and rating drift with continuous observations," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 423-444, March.
    2. Saikat Nandi, 1998. "Valuation models for default-risky securities: An overview," Economic Review, Federal Reserve Bank of Atlanta, vol. 83(Q 4), pages 22-35.
    3. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Nicoló Andrea Caserini & Paolo Pagnottoni, 2022. "Effective transfer entropy to measure information flows in credit markets," Statistical Methods & Applications, Springer;Società Italiana di Statistica, vol. 31(4), pages 729-757, October.

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