Calibration of PD term structures: to be Markov or not to be

The probability of default (PD) for a client is a fundamental risk parameter in credit risk management. It is common practice to assign to every rating grade in a bank's master scale a one-year PD in line with regulatory requirements (see Basel Committee on Banking Supervision, 2004). Table A shows an example for default frequencies assigned to rating grades from Standard & Poor's (S&P).

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