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IEOR 4106: Introduction to OR: Stochastic Models
Spring 2009, Professor Whitt
A Markov Chain Example in Credit Risk Modelling
This is a concrete example of a Markov chain from ﬁnance. Speciﬁcally, this come from p.626
627 of Hull’s
Options, Futures, and Other Derivatives
, 5th edition. This is not a homework
assignment. Questions are posed, but nothing is required.
Background.
Over time, bonds are liable to move from one rating category to another. This is sometimes
referred to as
credit ratings migration
. Rating agencies produce from historical data a
ratings
transition matrix
. This matrix show the probabiltiy of a bond moving from one rating to another
during a certain period of time. Usually the period of time is one year.
Below is a table giving a rating transition matrix produced from historical data by Standard
Table 1: Oneyear transition probabilities matrix.
Initial
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This note was uploaded on 01/26/2011 for the course IEOR 4106 taught by Professor Whitt during the Spring '08 term at Columbia.
 Spring '08
 Whitt

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