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Credit ratings and credit risk

Author

Listed:
  • Jens Hilscher

    () (International Business School, Brandeis University)

  • Mungo Wilson

    () (University of Oxford)

Abstract

This paper investigates the information in corporate credit ratings. We examine the extent to which firms' credit ratings measure raw probability of default as opposed to systematic risk of default, a firm's tendency to default in bad times. We find that credit ratings are dominated as predictors of corporate failure by a simple model based on publicly available financial information (`failure score'), indicating that ratings are poor measures of raw default probability. However, ratings are strongly related to a straightforward measure of systematic default risk: the sensitivity of firm default probability to its common component (`failure beta'). Furthermore, this systematic risk measure is strongly related to credit default swap risk premia. Our findings can explain otherwise puzzling qualities of ratings.

Suggested Citation

  • Jens Hilscher & Mungo Wilson, 2011. "Credit ratings and credit risk," Working Papers 31, Brandeis University, Department of Economics and International Businesss School.
  • Handle: RePEc:brd:wpaper:31
    as

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    File URL: http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP31.pdf
    File Function: First version, 2011
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    References listed on IDEAS

    as
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    Cited by:

    1. in ’t Veld, Daan & van Lelyveld, Iman, 2014. "Finding the core: Network structure in interbank markets," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 27-40.
    2. Harald Hau & Sam Langfield & David Marques-Ibanez, 2013. "Bank ratings: what determines their quality?," Economic Policy, CEPR;CES;MSH, vol. 28(74), pages 289-333, April.
    3. repec:wsi:afexxx:v:09:y:2014:i:02:n:s2010495214400041 is not listed on IDEAS
    4. repec:wsi:rpbfmp:v:17:y:2014:i:01:n:s0219091514500052 is not listed on IDEAS
    5. Holden, Steinar & Natvig, Gisle James & Vigier, Adrien, 2012. "An Equilibrium Model of Credit Rating Agencies," Memorandum 01/2013, Oslo University, Department of Economics.

    More about this item

    Keywords

    Credit Rating; Credit Risk; Default Probability; Forecast Accuracy; Systematic Default Risk;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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