Credit ratings and credit risk
AbstractThis 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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Bibliographic InfoPaper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 31.
Length: 54 pages
Date of creation: Jun 2011
Date of revision:
Credit Rating; Credit Risk; Default Probability; Forecast Accuracy; Systematic Default Risk;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-07-13 (All new papers)
- NEP-BAN-2011-07-13 (Banking)
- NEP-BEC-2011-07-13 (Business Economics)
- NEP-CFN-2011-07-13 (Corporate Finance)
- NEP-RMG-2011-07-13 (Risk Management)
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