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On the information content of credit ratings and market-based measures of default risk

Author

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  • Gredil, Oleg R.
  • Kapadia, Nishad
  • Lee, Jung Hoon

Abstract

We examine the ability of ratings and market-based measures to predict defaults. Although market-based measures are more accurate at horizons up to one year, ratings complement market-based measures and are not redundant in predicting defaults across horizons. Market-based measures differ from ratings in that they respond to both cash-flow and discount-rate news, while ratings respond primarily to cash-flow news, which is more informative of future defaults. Ratings ignore transitory shocks to credit risk, while market-based measures do not. Rating agencies respond to transitory shocks with watches rather than downgrades. Ratings are more informative during expansions and for speculative grade firms.

Suggested Citation

  • Gredil, Oleg R. & Kapadia, Nishad & Lee, Jung Hoon, 2022. "On the information content of credit ratings and market-based measures of default risk," Journal of Financial Economics, Elsevier, vol. 146(1), pages 172-204.
    • Handle: RePEc:eee:jfinec:v:146:y:2022:i:1:p:172-204
    DOI: 10.1016/j.jfineco.2022.07.005
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    1. Wei, Lu & Miao, Xiyuan & Jing, Haozhe & Liu, Zhidong & Xie, Zezhong, 2023. "Bank risk aggregation based on the triple perspectives of bank managers, credit raters, and financial analysts," Finance Research Letters, Elsevier, vol. 57(C).
    2. Itay Goldstein, 2023. "Information in Financial Markets and Its Real Effects," Review of Finance, European Finance Association, vol. 27(1), pages 1-32.
    3. Gianmarco Bet & Francesco Dainelli & Eugenio Fabrizi, 2023. "The financial health of a company and the risk of its default: Back to the future," Papers 2302.10140, arXiv.org.

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    More about this item

    Keywords

    Credit ratings; Credit Default Swaps; Default probability; Term strucutre of default risk;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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