On a multivariate Markov chain model for credit risk measurement |
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| Authors: | Tak-Kuen Siu Wai-Ki Ching S Eric Fung Michael K Ng¶ |
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| Institution: | 1. Department of Actuarial Mathematics and Statistics , School of Mathematical and Computer Sciences, Heriot-Watt University , Edinburgh EH14 4AS, UK T.K.Siu@ma.hw.ac.uk;3. Department of Mathematics , University of Hong Kong , Pokfulam Road, Hong Kong;4. Department of Mathematics , Hong Kong Baptist University , Kowloon Tong, Hong Kong |
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| Abstract: | In this paper, we use credibility theory to estimate credit transition matrices in a multivariate Markov chain model for credit rating. A transition matrix is estimated by a linear combination of the prior estimate of the transition matrix and the empirical transition matrix. These estimates can be easily computed by solving a set of linear programming (LP) problems. The estimation procedure can be implemented easily on Excel spreadsheets without requiring much computational effort and time. The number of parameters is O(s2 m2 ), where s is the dimension of the categorical time series for credit ratings and m is the number of possible credit ratings for a security. Numerical evaluations of credit risk measures based on our model are presented. |
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| Keywords: | Correlated credit migrations Linear programming Transition matrices Credibility theory |
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