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Credit Risk [12]

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Bullet points include: Portfolio of m credit exposures held between t and T. Each has credit rating that takes one of J values, and rating follows a Markov chain. Probability of moving from rating i to rating j is pi i,j. Usually between t and t+1 (say one year’s time, if multi-period simulation, or between t and T, if single period – how often might portfolio be repositioned?); pi i,j possibly also a function of t. Assume default stat is J’th state, then pi i,J is (one-year) probability of default for i-rated exposure. Transition matrix (e.g. estimated from historical ratings transitions data)

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