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| On Sovereign Credit Migration: Small-sample properties and rating evolution by Ana-Maria Fuertes of the City University London, and September 15, 2005 Abstract: This paper compares the finite-sample properties of sovereign credit migration estimators and investigates the presence of non-Markov effects in the rating process. To this end, we evaluate the conventional discrete multinomial estimator against two continuous hazard rate methods that differ in the treatment of time-homogeneity. Bootstrap simulations of the rating generating process reveal interesting insights. Hazard rate estimators yield more accurate default probabilities. Time-homogeneity results in underestimated default probabilities and greater migration is suggested upon lifting the homogeneity assumption. The discrepancies between homogeneous and heterogeneous estimators are, however, less marked than those between discrete and continuous estimators. There is evidence of non-Markov effects in sovereign ratings. Downgrade momentum and negative duration effects are present consistent with the evidence for corporates. These findings have important implications for risk management, economic capital and pricing of credit sensitive instruments. JEL Classification: C13, C41, G21, G28. Keywords: Sovereign credit ratings, Rating transitions, Markov chain, Time-heterogeneity, Rating momentum, Duration effects. Books Referenced in this Paper: (what is this?)
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