By Edward I. Altman
Read or Download Corporate Bond Rating Drift: An Examination of Credit Quality Rating Changes over Time PDF
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Extra resources for Corporate Bond Rating Drift: An Examination of Credit Quality Rating Changes over Time
With the exception of BaIBB ratings, all of the other rating categories show more stability-that is, a greater proportion of issues unchanged-in our study than in the Moody's study for the same holding period horizons. This difference in stability is particularly marked for the 5- and 10-year horizons. Part of these differences may be explained by the fact that the Moody's results include 1990, a fairly unstable year, particularly for downgrades, and our results do not. Upon closer scrutiny, however, the 1990 results appear to be no different from those for the average year during the 1982-89 period (see Lucas and Lonski 1991, Empirical Analysis of Bond Rating Drift TABLE 8.
Of the models examined, the Markov stationary and nonstationary models performed equally well in the back test. The Markov stationary model was not able to extend its superiority from the in-sample compatibility to the out-of-sample back test, however. Moreover, the results should be carefully interpreted with regard to this model. By definition, it is assumed to have constant proportions of stayers and a constant mover transition matrix. In reality, the proportions of stayers and the mover matrix varied from time to time during the test period-for example, the 1970s had fewer movers than did the 1980s.
Table 19, for example, shows net changes in the proportion of new-issue A-rated and BBB-rated bonds based strictly on one-year historical experience. Combining the short-term gains and losses from these expected rating changes with expected loss rates and amounts from expected defaults, an analyst could more precisely estimate changes in a portfolio's value. An analysis that includes different interest rate scenarios would be even more complete. The collateralized bond obligation market would seem to be an excellent application of our findings.