Migration Correlation: Estimation Method and Application to French Corporates Ratings

One major topic in empirical studies on Finance is the correlation of default risk. Correlation is a main driver for credit risk on a credit portfolio and for bank's capital requirement under the Basel II Accord. However, empirical evidence on the magnitude of correlation is rather scarce, mainly due to data limitation. First, the aim of this paper is to clarify the notion of correlation which depends on the underlying distributions and variables of interest. We suggest a general framework in which different types of correlations are precisely defined. Then, we discuss some implications of the type of correlation needed for the computation of the capital requirements. Then, the migration correlations are estimated using a large database of ratings and bankruptcies from the Banque de France.