SOLUTION: Models for Credit Risk Credit rating Finance Diagram

Please view explanation and answer below.

a)

b)
Probability between t = 2 and t = 6 is given by

P=∫263002+10t−t2dt

P=3001[150t+60t2−900t3]

Applying the limits

P=3001[1506+6062−90063] −3001[1502+6022−90023]

P=3001[0.4−0.071] =0.00109

Hence required probability = 1 – P = 1- 0.00109 = 0.99891

c)
The two-state model that has been incorporated in the first task of this assignment features a
quadratic form for the default transition intensity that has been used by the credit analyst. From
the results obtained in numbers 1 and 2, it is clear that this type of model does not allow the
default transition intensity to depend on either time or economic growth. However this factor can
be changed primarily by opting for a more versatile scale. Making use of a large data set
provided by the shipping company, the credit analyst can alter the results and ensure dependency
on economic growth and time, from the default transition intensity….