The structure of credit risk: spread volatility and ratings transitions

Working Paper no. 131
By Rudiger Kiesel, William Perraudin and Alex Taylor

Knowing the relative riskiness of different types of credit exposure is important for policy-makers designing regulatory capital requirements and for firms allocating economic capital. This paper analyses the risk structure of credit exposures with different maturities and credit qualities. We focus particularly on risks associated with (i) ratings transitions and (ii) spread changes for given ratings. We show that, for high-quality debt, most risk stems from spread changes. This is significant because several recently proposed credit risk models assume no spread risk.

The structure of credit risk: spread volatility and ratings transitions