Measurement and Estimation of Credit Migration Matrices

Wharton Financial Institutions Center Working Paper No. 03-08

44 Pages Posted: 9 May 2003

See all articles by Yusuf Jafry

Yusuf Jafry

Massachusetts Institute of Technology (MIT)

Til Schuermann

Oliver Wyman

Date Written: April 2003

Abstract

Credit migration matrices are cardinal inputs to many risk management applications. Their accurate estimation is therefore critical. We explore three approaches, cohort and two variants of duration - time homogeneous and non-homogeneous - and the resulting differences, both statistically through matrix norms and economically through credit portfolio and credit derivative models. We develop a testing procedure to assess statistically the differences between migration matrices using bootstrap techniques. The method can have substantial economic import: economic credit risk capital differences between economic regimes, recession vs. expansion, can be as large as difference implied by different estimation techniques. Ignoring the efficiency gain inherent in the duration methods by using the cohort method instead is more damaging that making a (possibly false) assumption of time-homogeneity.

Keywords: Credit risk, risk management, matrix norms, bootstrapping, credit derivatives

JEL Classification: C15, C41, G21, G28

Suggested Citation

Jafry, Yusuf and Schuermann, Til, Measurement and Estimation of Credit Migration Matrices (April 2003). Wharton Financial Institutions Center Working Paper No. 03-08. Available at SSRN: https://ssrn.com/abstract=394021 or http://dx.doi.org/10.2139/ssrn.394021

Yusuf Jafry

Massachusetts Institute of Technology (MIT) ( email )

50 Memorial Drive
Cambridge, MA 02139-4307
United States

Til Schuermann (Contact Author)

Oliver Wyman ( email )

1166 6th Avenue
New York City, NY
United States

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