What does credit migration risk refer to?

Credit migration risk refers to the potential for changes in the credit quality of a borrower or a bond issuer that could affect the value of a fixed income investment. This concept recognizes that the creditworthiness of borrowers can shift over time, leading to changes in the ratings assigned to these borrowers by credit rating agencies.

When credit quality deteriorates, it typically results in wider credit spreads, meaning the difference in yield between a corporate bond and a government bond with similar maturity increases. This widening of spreads reflects increased risk perceived by investors regarding the likelihood of default or a downgrade in credit quality. Therefore, identifying credit migration risk involves understanding how changes in credit ratings and perceived creditworthiness can lead to variations in pricing and investment returns.

Although other options pertain to aspects of credit risk, they do not encapsulate the specific nature of credit migration risk, which is fundamentally about shifts in ratings leading to changes in spread dynamics.