Chapter 5. Migration Matrices and the Markov Chain Approach

Jarrow et al. (1997) (hereafter JLT) were the first to model default and transition probabilities by using a Markov chain on a finite state space The model and its relevance for determining risk-neutral migration matrices will be descibed in more detail in Chapter 8. Here we will concentrate on the definition and properties of discrete and continuous-time transition matrices.

5.1. The Markov Chain Approach

The state space S represents the different rating classes. Hereby, state S = 1 denotes the best credit rating; state K represents the default case. Hence, in the discrete case, the ...

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