Changes in Migration Matrices and Credit VAR - a New Class of Difference Indices

In credit risk management, migration or transition matrices are major inputs for risk management, Credit Value-at-Risk or derivative pricing. After reviewing distance measures for migration matrices we propose some new directed difference indices to measure changes in migration behavior in a more risk-sensitive way. We quantify the changes of the classical distance measures and the new distance indices based on Moody's credit migration history from 1982-2001. We study the relationship between the difference indices, business cycle effects and changes in risk capital for exemplary credit portfolios. Our findings strongly support the usefulness of the derived distance indices and its capability to indicate cyclical behavior or changes in credit VaR. We recommend the use of the indices in risk management for internal credit and loan portfolios