Rating Migration and Bond Valuation: Ahistorical Interest Rate and Default Probability Term Structures

The study extends the theoretical framework proposed to decompose rating migration matrices from bond market price data. Method to decompose default probability term structures for and from interest rate term structures for different rating categories, is delineated and empirically evaluated. Emphasis is squarely on using ahistorical (non-historical) market data, and utilizing actual market perceptions regarding default probabilities. The method naturally allows a mapping and transitioning between interest rate term structures and default probability term structures. Mapping to and fro interest rate term structures and default probability term structures introduces an additional level of triangulation and evaluation. The study examines the corresponding interest rate term structures of the default probability term structures of a typical rating migration matrix, and the corresponding default probability term structures of a typical market interest rate term structure set. It is found that the default probability term structures decomposed from market interest rate term structures significantly differ from rating migration matrix based default probability term structures. This may point to differing views on default probability term structures.