A score-test on measurement errors in rating transition times

We model credit rating histories as continuous-time discrete-state Markov processes. Infrequent monitoring of the debtors' solvency will result in erroneous observations of the rating transition times, and consequently in biased parameter estimates. We develop a score test against such measurement errors in the transition data that is independent of the error distribution. We derive the asymptotic chi-square distribution for the test statistic under the null by stochastic limit theory. The test is applied to an international corporate portfolio, while accounting for economic and debtor-specific covariates. The test indicates that measurement errors in the transition times are a real problem in practice.