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On the Nonlinearity of the Financial Ratios-Credit Ratings Relationship

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  • Afef Feki Krichene
  • Walid Khoufi

Abstract

In this paper, we study the specificity of financial ratios in determining credit ratings. Specifically, we examine the nonlinearity of the financial ratios-credit ratings relationship. Among financial ratios, the interest coverage and debt coverage ratios have the most pronounced effect on credit ratings. To determine the form of the nonlinearity, the interest and debt coverage ratios are divided to four sub-variables with different weights associated to each increment. We find that different coefficients are associated to different increments of the interest coverage and debt coverage ratios. An interest coverage ratio loses all significance when it is less than zero and when it exceeds 20. Similarly, a debt coverage ratio loses all significance when it less than negative one and when it exceeds one. Our results confirm the nonlinearity of the financial ratios-credit rating relationship.

Suggested Citation

  • Afef Feki Krichene & Walid Khoufi, 2016. "On the Nonlinearity of the Financial Ratios-Credit Ratings Relationship," Applied Finance and Accounting, Redfame publishing, vol. 2(2), pages 65-70, August.
    • Handle: RePEc:rfa:afajnl:v:2:y:2016:i:2:p:65-70
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    References listed on IDEAS

    as
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    4. Poon, Winnie P. H., 2003. "Are unsolicited credit ratings biased downward?," Journal of Banking & Finance, Elsevier, vol. 27(4), pages 593-614, April.
    5. Marshall E. Blume & Felix Lim & A. Craig Mackinlay, 1998. "The Declining Credit Quality of U.S. Corporate Debt: Myth or Reality?," Journal of Finance, American Finance Association, vol. 53(4), pages 1389-1413, August.
    6. Pogue, Thomas F. & Soldofsky, Robert M., 1969. "What's in a Bond Rating*," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 4(2), pages 201-228, June.
    7. Marshall E. Blume & Felix Lim & A. Craig MacKinlay, "undated". "The Declining Credit Quality of US Corporate Debt: Myth or Reality?," Rodney L. White Center for Financial Research Working Papers 03-98, Wharton School Rodney L. White Center for Financial Research.
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    More about this item

    Keywords

    Financial ratios; credit rating; nonlinearity; increments; weights;
    All these keywords.

    JEL classification:

    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

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