Kaniovski, Yuriy M., Georg Ch. Pflug, "Risk Assessment for Credit Portfolios: A coupled Markov chain model", Journal of Banking & Finance, Vol. 31, No. 8, (August 2007), pp. 2303-2323.
Abstract: Credit portfolios, as for instance Collateralized Debt Obligations (CDO's) consist of credits that are heterogeneous both with respect to their ratings and the involved industry sectors. Estimates for the transition probabilities for different rating classes are well known and documented. We develop a Markov chain model, which uses the given transition probability matrix as the marginal law, but introduces correlation coefficients within and between industry sectors and between rating classes for the joint law of migration of all components of the portfolio.
Keywords: Credit risk, Collateralized debt obligation (CDO), Correlation coefficient, Coupling, Loss distribution, Cascade