Rating System Cyclicality

Definition

Rating System Cyclicality refers to characteristics of a Credit Rating System with respect to it dynamic response to evolving economic (and thus credit conditions).

Point in Time System Behaviour

A fully cyclical rating system or ‘Point-in-time’ (PiT) would see an economic downturn picked up through migration of exposures to lower rating grades and therefore no increase in default rate within a grade.

Through the Cycle System Behaviour

At the other extreme a non-cyclical or ‘Through-the-cycle’ (TtC) rating system does not respond to an economic downturn with grade migration, but the default rate within a grade increases instead.

Assessment of Cyclicality

A direct measure of cyclicality in terms of rating system based Probability of Default measures and observed Default Rate is given by

$C = \frac{ \mbox{PD}_t - \mbox{PD}_{t-1}}{\mbox{DR}_t - \mbox{DR}_{t-1}}$

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