Evidence of non-Markovian behavior in the process of bank rating migrations

This paper estimates transition matrices for the ratings on …nancial insti-tutions, using an unusually informative data set. We show that the processof rating migration exhibits signi…cant non-Markovian behavior, in the sensethat the transition intensities are a¤ected by macroeconomic and bank spe-ci…c variables. We illustrate how the use of a continuous time frameworkmay improve the estimation of the transition probabilities. However, thetime homogeneity assumption, frequently done in economic applications,does not hold, even for short time intervals. Thus, the information providedby migrations alone is not enough to forecast the future behavior of ratings.The stage of the business cycle should be taken into account, and individualcharacteristics of banks must be considered as well.