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Credit ratings and credit risk

Author

Listed:
  • Jens Hilscher

    (International Business School, Brandeis University)

  • Mungo Wilson

    (University of Oxford)

Abstract

This paper investigates the information in corporate credit ratings. We examine the extent to which firms' credit ratings measure raw probability of default as opposed to systematic risk of default, a firm's tendency to default in bad times. We find that credit ratings are dominated as predictors of corporate failure by a simple model based on publicly available financial information (`failure score'), indicating that ratings are poor measures of raw default probability. However, ratings are strongly related to a straightforward measure of systematic default risk: the sensitivity of firm default probability to its common component (`failure beta'). Furthermore, this systematic risk measure is strongly related to credit default swap risk premia. Our findings can explain otherwise puzzling qualities of ratings.

Suggested Citation

  • Jens Hilscher & Mungo Wilson, 2011. "Credit ratings and credit risk," Working Papers 31, Brandeis University, Department of Economics and International Business School.
    • Handle: RePEc:brd:wpaper:31
    as

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    File URL: http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP31.pdf
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    References listed on IDEAS

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    Cited by:

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    2. Youngtae Yoo & Jaehong Lee & Jinho Chang, 2014. "Distinctive Features of BBB- and BB-Graded Firms Using Earnings Management and Conservatism: Evidence from the Korean Market," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 17(01), pages 1-31.
    3. Steinar Holden & Gisle James Natvik & Adrien Vigier, 2012. "An equilibrium model of credit rating agencies," Working Paper 2012/23, Norges Bank.
    4. Bi-Juan Chang & Jow-Ran Chang & Mao-Wei Hung, 2014. "Searching For Landmines In Equity Markets," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 9(02), pages 1-24.
    5. T.G. Saji, 2018. "Financial Distress and Stock Market Failures: Lessons from Indian Realty Sector," Vision, , vol. 22(1), pages 50-60, March.
    6. in ’t Veld, Daan & van Lelyveld, Iman, 2014. "Finding the core: Network structure in interbank markets," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 27-40.

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    More about this item

    Keywords

    Credit Rating; Credit Risk; Default Probability; Forecast Accuracy; Systematic Default Risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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