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Credit ratings and credit risk

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Author Info

  • 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.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP31.pdf
File Function: First version, 2011
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Bibliographic Info

Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 31.

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Length: 54 pages
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:brd:wpaper:31

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Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/
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Related research

Keywords: Credit Rating; Credit Risk; Default Probability; Forecast Accuracy; Systematic Default Risk;

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References

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Cited by:
  1. Hau, Harald & Langfield, Sam & Marqués Ibañez, David, 2012. "Bank ratings: What determines their quality?," CEPR Discussion Papers 9171, C.E.P.R. Discussion Papers.
  2. Bonner, C. & Eijffinger, S.C.W., 2012. "The Impact of the LCR on the Interbank Money Market," Discussion Paper 2012-075, Tilburg University, Center for Economic Research.
  3. Holden, Steinar & Natvig, Gisle James & Vigier, Adrien, 2012. "An Equilibrium Model of Credit Rating Agencies," Memorandum 01/2013, Oslo University, Department of Economics.

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