The Estimation of Transition Matrices for Sovereign Credit Ratings 

Full paper available here.

Yen-Ting Hu, Ruediger Kiesel and William Perraudin

Rating transition matrices for sovereigns are an important input to risk management of portfolios of emerging market credit exposures. They are widely used both in credit portfolio management and to calculate future loss distributions for pricing purposes. However, few sovereigns and almost no low credit quality sovereigns have ratings histories longer than a decade, so estimating such matrices is difficult. This paper shows how one may combine information from sovereign defaults observed over a longer period and a broader set of countries to derive estimates of sovereign transition matrices.