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Multiple ratings and credit standards: differences of opinion in the credit rating industry

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  • Richard Cantor
  • Frank Packer

Abstract

Rating-dependent financial regulators assume that the same letter ratings from different agencies imply the same levels of default risk. Most \\"third\\" agencies, however, assign significantly higher ratings on average than Moody's and Standard & Poor's. We show that, contrary to the claims of some rating industry professionals, sample selection bias can account for at most half of the observed average difference in ratings. We also investigate the economic rationale for using multiple rating agencies. Among the many variables considered, only size and bond-issuance history are consistently related to the probability of an issuer seeking third ratings. The probability ties to improve their standing under rating-dependent regulations.

Suggested Citation

  • Richard Cantor & Frank Packer, 1996. "Multiple ratings and credit standards: differences of opinion in the credit rating industry," Staff Reports 12, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:12
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    Cited by:

    1. Pesaran, M. Hashem & Schuermann, Til & Treutler, Bjorn-Jakob & Weiner, Scott M., 2006. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(5), pages 1211-1261, August.
    2. Miloš Božovic & Branko Uroševic & Boško Živkovic, 2011. "Credit Rating Agencies and Moral Hazard," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(2), pages 219-227, June.
    3. Cantor, Richard & Packer, Frank, 1997. "Differences of opinion and selection bias in the credit rating industry," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1395-1417, October.
    4. Yusuf Jafry & Til Schuermann, 2003. "Metrics for Comparing Credit Migration Matrices," Center for Financial Institutions Working Papers 03-09, Wharton School Center for Financial Institutions, University of Pennsylvania.
    5. Alexandr Karminsky & Anatoly Peresetsky, 2009. "Ratings as Measure of Financial Risk: Evolution, Function and Usage," Journal of the New Economic Association, New Economic Association, issue 1-2, pages 86-102.
    6. Arie Melnik & Doron Nissim, 2003. "Debt issue costs and issue characteristics in the Eurobond market," ICER Working Papers 09-2003, ICER - International Centre for Economic Research.
    7. Menz, Klaus-Michael, 2010. "Market discipline and the evaluation of Euro financial bonds--An empirical analysis," Research in International Business and Finance, Elsevier, vol. 24(3), pages 315-328, September.
    8. Daryl Koehn & Joe Ueng, 2005. "Evaluating the Evaluators: Should Investors Trust Corporate Governance Metrics Ratings?," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 9(2), pages 111-128, June.
    9. Lawrence White, 2005. "Good Intentions Gone Awry: A Policy Analysis of the SEC's Regulation of the Bond Rating Industry," Working Papers 05-16, New York University, Leonard N. Stern School of Business, Department of Economics.
    10. Eichengreen, Barry & Mody, Ashoka, 2000. "Lending booms, reserves and the sustainability of short-term debt: inferences from the pricing of syndicated bank loans," Journal of Development Economics, Elsevier, vol. 63(1), pages 5-44, October.
    11. Wilhelm Jr, William J & Chen, Zhaohui, 2005. "The Industrial Organization of Financial Market Information Production," CEPR Discussion Papers 5314, C.E.P.R. Discussion Papers.
    12. Ying Yi Tsai & Li-Gang Liu, 2010. "Emergence of Rating Agencies : Implications for Establishing a Regional Rating Agency in Asia," Finance Working Papers 22824, East Asian Bureau of Economic Research.
    13. Morales, Jorge & Tuesta, Pedro, 1998. "Calificaciones de crédito y riesgo país," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 3.
    14. Mattarocci, Gianluca, 2005. "Il rapporto tra impresa e agenzia di rating: la soluzione del multi-rating," MPRA Paper 4295, University Library of Munich, Germany, revised Mar 2005.
    15. Santos, Joao A.C., 2006. "Why firm access to the bond market differs over the business cycle: A theory and some evidence," Journal of Banking & Finance, Elsevier, vol. 30(10), pages 2715-2736, October.
    16. Griep, Clifford & De Stefano, Michael, 2001. "Standard & Poor's official response to the Basel Committee's proposal," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 149-169, January.
    17. Kraft, Pepa, 2015. "Do rating agencies cater? Evidence from rating-based contracts," Journal of Accounting and Economics, Elsevier, vol. 59(2), pages 264-283.
    18. Til Schuermann & Yusuf Jafry, 2003. "Measurement and Estimation of Credit Migration Matrices," Center for Financial Institutions Working Papers 03-08, Wharton School Center for Financial Institutions, University of Pennsylvania.
    19. Shin, Yoon S. & Moore, William T., 2003. "Explaining credit rating differences between Japanese and U.S. agencies," Review of Financial Economics, Elsevier, vol. 12(4), pages 327-344.
    20. Fausto Hernández-Trillo & Ricardo Smith, 2006. "Rating Sub-National Government Debt in LDCs: Does size matter?," Working papers DTE 370, CIDE, División de Economía.
    21. Schröder, Michael & Riedler, Jesper & Jaroszek, Lena & Lang, Gunnar & Hommel, Paul & Voll, Sebastian Simon, 2011. "Assessment of the cumulative impact of various regulatory initiatives on the European banking sector: Study," ZEW Expertises, ZEW - Leibniz Centre for European Economic Research, number 110523.
    22. David Brookfield & Phillip Ormrod, 2000. "Credit agency regulation and the impact of credit ratings in the international bond market," The European Journal of Finance, Taylor & Francis Journals, vol. 6(4), pages 311-331.
    23. Meryem Duygun & Huseyin Ozturk & Mohamed Shaban & Emili Tortosa-Ausina, 2014. "Quo Vadis, raters? A frontier approach to identify misratings in sovereign credit risk," Working Papers 2014/10, Economics Department, Universitat Jaume I, Castellón (Spain).

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