Quantitative Analysis: Dynamic Credit Ratings Model

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Quantitative Analysis - Dynamic Credit Ratings Model

Author : Nusheen Shoab
CID: 00755208

Applied Financial Research Project ,2014
Imperial College London

Project Specification

We are an Analytics Division of a Rating Agency offering ratings and advisory services to a large number of Corporate clients. The Analytics Division is approached by the Sales Division to enhance their credit ratings model i.e. upon having criticism from the user’s on its reliability, the ratings team has been asked to enhance their ratings model such that the model takes into account the changing economic circumstances.
The period of Global Financial Crisis provided staggering evidence of the problems caused by inadequate credit ratings. Many corporate
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We hereafter refer to the Merton model modified by Moody’s KMV(Crosbie & Bohn,2003) as the Merton/KMV model. The firm defaults when the debt exceeds equity. The default point acts as an absorbing barrier and as soon as the asset value hits this point , the firm is assumed to default. (Crosbie & Bohn, 2003) find that it is not unusual for a firm to not default when asset values reach book values, as many continue to service their debts due to the long term nature of some liabilities. KMV derives the default point to be somewhere between the total liabilities and current…show more content…
AIG faced the most difficult time during the crisis of 2008 when a series of events unfolded with the disclosure of financial losses and subsequent falling stock price. Figure – AIG’s declining stock price during Global Financial Crisis (GFC)
AIG’s financial crisis was intensified when its credit ratings were downgraded forcing it to post $14.5 billion in collateral resulting in a liquidity crisis.
The U.S. government seized control of American International Group Inc, in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system making it one of the biggest corporate bailouts in history. Prior to the crisis AIG enjoyed stability and was rated Aa2 in 2005. The company was downgraded subsequently to an A2 in 2008, A3 in 2009 and Baa1 in 2011.
Bank of America (BOA) is a multinational banking & financial services corporation. Bank of America was also downgraded to A1 & A2 by Moody’s in 2009 and 2011 respectively after having enjoyed a rating of Aa1 in 2007. It was further downgraded in 2012. According to Moody’s , these downgrades come in due to either problems in risk management or a history of high volatility . Figure – BOA’s stock price during Global Financial Crisis

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