Confidence sets for continuous-time rating

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Confidence sets for continuous-time rating

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Title: Confidence sets for continuous-time rating
Author: Christensen, Jens; Hansen, Ernst; Lando, David
Abstract: This paper addresses the estimation of default probabilities and associated confidence sets with special focus on rare events. Research on rating transition data has documented a tendency for recently downgraded issuers to be at an increased risk of experiencing further downgrades compared to issuers that have held the same rating for a longer period of time. To capture this non-Markov effect we introduce a continuous-time hidden Markov chain model in which downgrades firms enter into a hidden, ’excited’ state. Using data from Moody’s we estimate the parameters of the model, and conclude that both default probabilities and confidence sets are strongly influenced by the introduction of hidden excited states.
URI: http://hdl.handle.net/10398/8139
Date: 2010-07-02

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