Rating Transition Matrix Query

[Roshan Ramdas]

Hi David,

Just had a quick question with respect to the "6. Transition Matrix" tab on the workbook "T6.Malz.6_Credit_Risk".

I think that the 2 period transition matrix values should be simply a square of the 1 period values.

The 2 period transition matrix values on the s/sheet are not exact squares though and they are being populated by slightly complicated formulas......could you please explain the reason for this ??

Thank you,
Roshan

 

[David Harper CFA FRM]

Hi @Roshan Ramdas

You are absolutely correct: the n-period transition matrix is given by the [1-period matrix]^n; e.g., squared for a 2-period matrix (implicitly assumes Markovian independence).
The reason for the extra formula code is Excel-specific: it avoids using an array which is difficult (impossible?) to edit. So the squaring does occur in "=MMULT($C$5:$K$13,$C$5:$K$13)" This multiplies the range by itself. But then it is wrapped by INDEX() to avoid using an array; otherwise, this MMULT could be used by itself in favor of an array. I hope that explains, thanks!