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The economic function of credit rating agencies: what does the watchlist tell us?

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  • Bannier, Christina E.
  • Hirsch, Christian
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    Abstract

    Credit rating agencies do not only disclose simple ratings but announce watchlists (rating reviews) and outlooks as well. This paper analyzes the economic function underlying the review procedure. Using Moody's rating data between 1982 and 2004, we find that for borrowers of high creditworthiness, rating agencies employ watchlists primarily in order to improve the delivery of information. For low-quality borrowers, in contrast, the review procedure seems to have developed into an implicit contract `a la Boot, Milbourn, and Schmeits (2006), inducing the companies on watch to abstain from risk-augmenting actions. The agencies' economic role hence appears to have been enhanced from a pure information certification towards an active monitoring function. --

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    Paper provided by Frankfurt School of Finance and Management in its series Frankfurt School - Working Paper Series with number 124.

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    Date of creation: 2009
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    Handle: RePEc:zbw:fsfmwp:124

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    Keywords: Credit Rating Agencies; Credit Rating; Watchlist; Rating Review; Market Reaction; Event Study;

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    1. Lynnette D. Purda, 2007. "Stock Market Reaction To Anticipated Versus Surprise Rating Changes," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 30(2), pages 301-320.
    2. Boot, Arnoud W A & Milbourn, Todd, 2002. "Credit Ratings as Coordination Mechanism," CEPR Discussion Papers 3331, C.E.P.R. Discussion Papers.
    3. Heckman, James J, 1979. "Sample Selection Bias as a Specification Error," Econometrica, Econometric Society, vol. 47(1), pages 153-61, January.
    4. Cantor, Richard, 2004. "An introduction to recent research on credit ratings," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2565-2573, November.
    5. Holthausen, Robert W. & Leftwich, Richard W., 1986. "The effect of bond rating changes on common stock prices," Journal of Financial Economics, Elsevier, vol. 17(1), pages 57-89, September.
    6. Jo�O A. C. Santos & Andrew Winton, 2008. "Bank Loans, Bonds, and Information Monopolies across the Business Cycle," Journal of Finance, American Finance Association, vol. 63(3), pages 1315-1359, 06.
    7. Norden, Lars & Weber, Martin, 2004. "Informational efficiency of credit default swap and stock markets: The impact of credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2813-2843, November.
    8. Norden, Lars & Weber, Martin, 2004. "Informational Efficiency of Credit Default Swap and Stock Markets: The Impact of Credit Rating Announcements," CEPR Discussion Papers 4250, C.E.P.R. Discussion Papers.
    9. Loffler, Gunter, 2005. "Avoiding the rating bounce: why rating agencies are slow to react to new information," Journal of Economic Behavior & Organization, Elsevier, vol. 56(3), pages 365-381, March.
    10. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
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    Cited by:
    1. Bannier, Christina E. & Behr, Patrick & Güttler, André, 2009. "Rating opaque borrowers: why are unsolicited ratings lower?," Frankfurt School - Working Paper Series 133, Frankfurt School of Finance and Management.

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