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Credit Transition and Structural Shocks

Author

Listed:
  • Camilla Ferretti

    (Bank of Italy, 91 Via Nazionale, Roma 00184, Italy)

  • Giampaolo Gabbi

    (SDA Bocconi School of Management, Milano 20136, Italy)

  • Piero Ganugi

    (Department of Industrial Engineering, University of Parma, Parma 43100, Italy)

  • Pietro Vozzella

    (Department of Management and Law, University of Siena, Siena 53100, Italy)

Abstract

Credit risk involves not only the complexity of screening but also monitoring and estimating rating transition. The adoption of inadequate transition matrices causes a misevaluation of credit risk, a consequent misallocation of capital, with the prospect that the lending process will be affected by increasing transaction costs and limited rationality, especially after a shock. Comparing the mover–stayer and the Markov chain approaches to estimate the SME rating transition matrix, we find that the risk of a structural credit shock imposes flexible estimates not constrained by the long-run trajectory of borrowers. Improved migration estimation mitigates adverse selection in banks’ lending behavior. This conclusion is particularly true during economic downturns with the consequence of reducing the cyclicality and empowering the resilience of banks.

Suggested Citation

  • Camilla Ferretti & Giampaolo Gabbi & Piero Ganugi & Pietro Vozzella, 2022. "Credit Transition and Structural Shocks," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 12(01), pages 1-28, March.
    • Handle: RePEc:wsi:qjfxxx:v:12:y:2022:i:01:n:s2010139222400031
    DOI: 10.1142/S2010139222400031
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