The Impact of Downward Rating Momentum |
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Authors: | Andre Güttler and Peter Raupach |
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Institution: | (1) Department of Finance, Accounting and Real Estate, European Business School, International University Schloss Reichartshausen, 65375 Oestrich-Winkel, Germany;(2) Banking and Financial Supervision Department, Deutsche Bundesbank, W.-Epstein-Str. 14, 60431 Frankfurt, Germany |
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Abstract: | Rating downgrades are known to make subsequent downgrades more likely. We analyze the impact of this “downward momentum” on
credit portfolio risk and bond portfolio management. Using Standard&Poor’s ratings from 1996 to 2005, we apply a novel approach
to estimate a transition matrix that is sensitive to previous downgrades and contrast it with an insensitive benchmark matrix.
First, we find that, under representative economic conditions, investors who rely on insensitive transition matrices underestimate
the momentum-sensitive Value-at-Risk (VaR), on average, by 107 basis points. Second, we show that bond portfolio managers
should use our downgrade-sensitive probabilities of default as they seem to be better calibrated than momentum-insensitive
estimates. |
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Keywords: | |
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