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 7 years in a real corporate portfolio. Especially 1-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.
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Weißbach, R., Tschiersch, P. & Lawrenz, C. Testing time-homogeneity of rating transitions after origination of debt. Empir Econ 36, 575–596 (2009). https://doi.org/10.1007/s00181-008-0212-3
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DOI: https://doi.org/10.1007/s00181-008-0212-3