New York, July 15, 2021: Kamakura Corporation has introduced a new Future Ratings model for its Kamakura Risk Information Services (KRIS) subscribers. This model complements the revised Implied Ratings Model, which was announced earlier in the year. Development of the model was led by Kamakura Corporation Founder, CEO and Chairman Dr. Donald van Deventer, KRIS Managing Director Mark Mesler, and Chief Data Scientist Dr. Sou-Cheng Choi. Based on feedback from clients and other market participants, the model incorporates KRIS default probabilities and other key inputs to forecast a probability distribution for upgrades and downgrades for firms that are currently rated.
Outstanding global rated debt is estimated to be $22 trillion, of which 77% is rated investment grade with BBB being the largest component at $8.4 trillion. Of the outstanding non-investment grade debt, BB is the largest component at $2.56 trillion. With almost half of outstanding debt falling into these two ratings, a combination of KRIS default probabilities with a high-quality prediction of potential rating changes is critical for investors and portfolio managers.
A very large component of the uncertainty in rating agency behavior is attributable to the long periods of stability in ratings during times of great change in default probabilities, financial ratios, stock price inputs and macroeconomic factors. In forecasting future ratings, Kamakura clients expect that the current default risk of the firm should dominate the exercise, and that view was confirmed by the model development process.
The new Future Ratings model uses an extensive set of inputs as of the observation date, including the following:
- KRIS default probabilities for all rated firms.
- The stock-price history of all rated firms.
- The financial-statement history of all rated firms.
- The history of all relevant macroeconomic factors.
- The history of ratings for all rated firms, including the transition matrix that would have been calculated as of the observation date.
Using a modified ordered logistic regression approach, the KRIS Future Ratings Model generates the best possible estimate of 20 future rating grades for each firm on each observation date. This contrasts with a transition matrix that would be available on each observation date, since those transition probabilities will be the same for all firms that have the same rating on the observation date. Kamakura-calculated transition matrices are also inputs to the Future Ratings Model.
From these two sets of probabilities, KRIS provides, for both the Future Ratings model and the transition matrix approach, the following probabilities:
- The probability of an upgrade, i.e., the sum of probabilities for all ratings that are better than the current rating.
- The probability of a downgrade, i.e., the sum of probabilities for all ratings that are worse than the current rating.
- The probability of an investment grade rating, i.e., the sum of probabilities for all ratings of BBB- or better.
- The probability of a non-investment grade rating, i.e., the sum of probabilities for all ratings of BB+ or worse.
Eric Penanhoat, Kamakura Corporation’s Managing Director for Quantitative Risk, said Thursday, “The Implied Rating and Future Ratings models complement each other and provide details and insights into the relationship between the probabilities of default and S&P ratings on both a current and forward-looking basis. One can easily highlight correlations and deviations today and up to 10 years forward. Credit analysts, risk managers, quantitative investment analysts, and portfolio managers can use the rich dataset to finetune their decisions by better understanding the relationship between credit ratings and reduced-form default probabilities. Kamakura models, data and analytics provide an essential link between fundamental credit analysis and robust quantitative analytics in probabilities of default and likely ratings changes.”
The following report shows the net probability of upgrade or downgrade for select high-yield issuers.
The chart shows the probability among issuers rated BBB-, so the tool can be used to measure the risk of a fallen angel or the opportunity for an upgrade.
The new Future Ratings Model and the related Kamakura Technical Guide are available to all current KRIS subscribers.
About Kamakura Corporation
Founded in 1990, Honolulu-based Kamakura Corporation is a leading provider of risk management information, processing, and software. Kamakura was recognized as a category leader in the Chartis Report, Technology Solutions for Credit Risk 2.0 2018. Kamakura was named to the World Finance 100 by the editor and readers of World Finance magazine in 2017, 2016 and 2012. In 2010, Kamakura was the only vendor to win two Credit Magazine innovation awards., Kamakura Risk Manager, first sold commercially in 1993 and now in version 10.0.5, is the first enterprise risk management system for users focused on credit risk, asset and liability management, market risk, stress testing, liquidity risk, counterparty credit risk, and capital allocation from a single software solution. The KRIS public firm default service was launched in 2002. The KRIS sovereign default service, the world’s first, was launched in 2008, and the KRIS non-public firm default service was offered beginning in 2011. Kamakura added its U.S. Bank default probability service in 2014.
Kamakura has served more than 330 clients with assets ranging in size from $1.5 billion to $7.0 trillion. Current clients have a combined “total assets” or “assets under management” in excess of $28 trillion. Its risk management products are currently used in 47 countries, including the United States, Canada, Germany, the Netherlands, France, Austria, Switzerland, the United Kingdom, Russia, Ukraine, South Africa, Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Singapore, Sri Lanka, Taiwan, Thailand, Vietnam, and many other countries in Asia, Europe and the Middle East.
To follow risk commentary by Kamakura on a daily basis, please follow:
Kamakura CEO, Dr. Donald van Deventer (www.twitter.com/dvandeventer)
Kamakura President, Martin Zorn (www.twitter.com/riskmgrhi)
Kamakura’s official twitter account (www.twitter.com/KamakuraCo).
For more information, please contact:
Kamakura Corporation
2222 Kalakaua Avenue, Suite 1400, Honolulu, Hawaii 96815
Telephone: 1-808-791-9888
Facsimile: 1-808-791-9898
Information: info@kamakuraco.com
Web site: www.kamakuraco.com