Feng, Dingan, Christian Gourieroux, Joann Jasiak, "The Ordered Qualitative Model for Credit Rating Transitions", Journal of Empirical Finance, Vol. 15, No. 1, (January 2008), pp. 111-130.
Abstract: Information on the expected changes in credit quality of obligors is contained in credit migration matrices which trace out the movements of firms across ratings categories in a given period of time and in a given group of bond issuers. The rating matrices provided by Moody's, Standard & Poor's and Fitch became crucial inputs to many applications, including the assessment of risk on corporate credit portfolios (CreditVar) and credit derivatives pricing. We propose a factor probit model for modeling and prediction of credit rating matrices that are assumed to be stochastic and driven by a latent factor. The filtered latent factor path reveals the effect of the economic cycle on corporate credit ratings, and provides evidence in support of the PIT (point-in-time) rating philosophy. The factor probit model also yields the estimates of cross-sectional correlations in rating transitions that are documented empirically but not fully accounted for in the literature and in the regulatory rules established by the Basle Committee.
Keywords: Credit rating, Migration, Migration correlation, Credit risk, Probit model, Latent factor, Business cycle.