Credit Calibration - The Effect of Model Time-step
Document ID: 2008-77 (previously 2008/01)
Published on: 1st February 2008
Author: Steven Morrison
The Barrie & Hibbert ESG can be run on different model time-steps – monthly, quarterly, semi-annual or annual. Within the context of the credit model, the model time-step determines the frequency at which we sample credit migrations. The unconditional probabilities of migration and default (i.e. probabilities unconditional on the market factor) are carefully chosen so that they are consistent between different model time-steps (for example, the annual transition matrix is equal to the semi-annual transition matrix squared). However, using our correlation model it is not obvious whether conditional probabilities of migration and default are independent of model time-step. In fact, as noted in Calibration Note 2007/018, the distribution of the proportion of issuers in a large portfolio defaulting over 1-year is different depending on whether we use a monthly or annual time-steps. This note presents further analysis of these effects.
