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Outline Rating agencies Markov chain for rating migrations Ratings-Based Models of Credit Risk Haipeng Xing Haipeng Xing AMS517, SUNY Stony Brook Ratings-Based Models of Credit Risk Outline Rating agencies Markov chain for rating migrations Outline 1 Rating agencies, rating factors and processes 2 Markov chain for rating migrations Haipeng Xing AMS517, SUNY Stony Brook Ratings-Based Models of Credit Risk
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Outline Rating agencies Markov chain for rating migrations Rating agencies I Rating agencies have a long tradition in the United States. For example, S&P traces its history back to 1860 and began rating the debt of corporate and government issuers more than 75 years ago. The Securities and Exchange Commission (SEC) has currently designated several agencies as “nationally recognized statistical rating organizations”, including Moody’s KMV, Standard & Poor’s, Fitch, or Thomson BankWatch. Although methodologies and standards di ff er from one rating agency to another, regulators generally do not make distinctions among the agencies. Furthermore, although there is a high congruence between the rating systems of Moody’s and S&P, di ff erent agencies might assign slightly di ff erent ratings for the same bond. The ratings given by rating agencies can be served as input data for several credit risk software models such as CreditMetrics of JP Morgan, a system that evaluates risks individually or across an entire portfolio. Haipeng Xing AMS517, SUNY Stony Brook Ratings-Based Models of Credit Risk Outline Rating agencies Markov chain for rating migrations Rating agencies II The rating agencies generally provide two di ff erent sorts of ratings: Issue-specific credit ratings and Issuer credit ratings . Issue-specific credit ratings are current opinions of the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or specific financial program. Issue-specific ratings also take into account the recovery prospects associated with the specific debt being rated. On the other hand, issuer credit ratings give an opinion of the obligor’s overall capacity to meet its financial obligations — that is, its fundamental creditworthiness. These so-called corporate credit ratings indicate the likelihood of default regarding all financial obligations of the firm. The practice of di ff erentiating issues in relation to the issuer’s overall creditworthiness is known as notching . Issues are notched up or down from the corporate credit rating level in accordance with established guideliness. Haipeng Xing AMS517, SUNY Stony Brook Ratings-Based Models of Credit Risk
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Outline Rating agencies Markov chain for rating migrations Rating agencies III Some of the rating agencies have historically maintained separate rating scales for long-term and short-term instruments. Long-term credit ratings, i.e., obligations with an original maturity of more than one year, are divided into several categories ranging such as AAA, AA, A, BBB, BB, B, CCC, and D. Ratings in the four highest categories, AAA, AA, A
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