The Impact of Downward Rating Momentum

34 Pages Posted: 4 Jan 2007 Last revised: 6 Apr 2010

See all articles by Andre Guettler

Andre Guettler

University of Ulm - Department of Mathematics and Economics; Halle Institute for Economic Research

Peter Raupach

Deutsche Bundesbank - Research Department

Date Written: November 12, 2007

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.

Keywords: Rating drift, Downward momentum, Credit portfolio risk, Value-at-Risk, Bond portfolio management, Calibration

JEL Classification: C41, G24, G32

Suggested Citation

Guettler, Andre and Raupach, Peter, The Impact of Downward Rating Momentum (November 12, 2007). Journal of Financial Services Research, Vol. 37, pp. 1–23, 2010. Available at SSRN: https://ssrn.com/abstract=954894

Andre Guettler (Contact Author)

University of Ulm - Department of Mathematics and Economics ( email )

Helmholzstrasse
Ulm, D-89081
Germany

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

Peter Raupach

Deutsche Bundesbank - Research Department ( email )

Wilhelm-Epstein-Str. 14
Frankfurt, 60431
Germany
+49 69 9566 8536 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
283
Abstract Views
1,596
rank
106,738
PlumX Metrics