Abstract Assuming a favorable or an adverse outcome for every combination of credit class and industry sector, binary string, termed as macroeconomic scenario, is considered. Given historical transition counts model dependence among credit-rating migrations, probability assigned to each the scenarios by maximizing likelihood function. Applications this distribution in financial risk analysis ar...

We study risk and return characteristics of CDOs using the market standard models. We find that fair spreads on CDO tranches are much higher than fair spreads on similarly-rated corporate bonds. Our results imply that credit ratings are not sufficient for pricing, which is surprising given their central role in structured finance markets. This illustrates limitations of the rating methodologies...

Could inflated credit ratings that provide new information have adverse ex-ante real effects? If so, why? In a debt-rollover game featuring a feedback loop, we show that when the risky projects have high upside returns, the credit rating agency’s (CRA) ex-ante real effects are negative, despite of its positive informational effects. This arises from the CRAs feedback effects: it strategically a...

We review different methods for simulating credit migrations in a nonparametric and discrete or continuous-time Markov chain framework. We suggest the application of a factor model approach in combination with the use of copulas for the joint dynamics of credit rating changes. While there are several applications of copulas in credit risk for modeling joint defaults, it lacks of the same intere...

Using the industry benchmark CreditGrades model to analyze credit default swap (CDS) spreads across a large number of companies during the 2007–09 credit crisis, the authors demonstrate that the performance of the model can be significantly improved by calibrating it with option-implied volatility rather than with historical volatility. Moreover, the advantage of using option-implied volatility...