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Are credit ratings valuable information?

  • Dirk Czarnitzki
  • Kornelius Kraft

Credit ratings are commonly used by lenders to assess the default risk, because every credit is connected with a possible loss. If the probability of a default is above a certain threshold, a credit will not be provided. The purpose of this study is to test whether credit ratings contribute valuable information on the creditworthiness of firms. Employing a large sample of Western German manufacturing firms, we investigate loan defaults. First, we estimate Probit models with publicly available information. Subsequently, we additionally use a credit rating and show that it contributes significantly to the regression fit. However, the publicly available information has an independent effect aside of the ratings. Simple calculations demonstrate that the interest rate has to increase significantly to compensate for a possible loss in case of default, if a firm has a weak rating.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100600749220
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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 17 (2007)
Issue (Month): 13 ()
Pages: 1061-1070

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Handle: RePEc:taf:apfiec:v:17:y:2007:i:13:p:1061-1070
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  1. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
  2. Ewert, Ralf & Szczesny, Andrea, 2001. "Countdown for the New Basle Capital Accord: Are German banks ready for the internal ratings-based approach?," CFS Working Paper Series 2001/05, Center for Financial Studies (CFS).
  3. William B. English & William R. Nelson, 1998. "Bank risk rating of business loans," Finance and Economics Discussion Series 1998-51, Board of Governors of the Federal Reserve System (U.S.).
  4. Ilia D. Dichev, 1998. "Is the Risk of Bankruptcy a Systematic Risk?," Journal of Finance, American Finance Association, vol. 53(3), pages 1131-1147, 06.
  5. Veall, Michael R & Zimmermann, Klaus F, 1996. " Pseudo-R-[superscript 2] Measures for Some Common Limited Dependent Variable Models," Journal of Economic Surveys, Wiley Blackwell, vol. 10(3), pages 241-59, September.
  6. Bongini, Paola & Laeven, Luc & Majnoni, Giovanni, 2002. "How good is the market at assessing bank fragility? A horse race between different indicators," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1011-1028, May.
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