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| Testing Homogeneity of Time-Continuous Rating Transitions by Rafael Weißbach of Dortmund University of Technology, August 23, 2005 Abstract: When modelling rating transitions as continuous-time Markov processes, in practice, time-homogeneity is a common assumption, yet restrictive, in order to reduce the complexity of the model. This paper investigates whether rating transition probabilities change after the origination of debt. Accordingly, we develop a likelihood-ratio test for the hypothesis of time-homogeneity. The alternative is a step function of transition intensities. The test rejects time-homogeneity for rating transitions observed over seven years in a real corporate portfolio. Especially one-year transition probabilities increase over the first year after origination. This time effect suggests that banks should manage their credit portfolios with respect to the age of debt. JEL Classification: C51, G11, G18, G33. Keywords: Portfolio credit risk, rating transitions, Markov model, time-homogeneity, likelihood ratio. Forthcoming in: Empirical Economics. Books Referenced in this Paper: (what is this?)
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