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Credit ratings and credit risk

  • Jens Hilscher

    ()

    (International Business School, Brandeis University)

  • Mungo Wilson

    ()

    (University of Oxford)

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.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP31.pdf
File Function: First version, 2011
Download Restriction: no

Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 31.

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Length: 54 pages
Date of creation: Jun 2011
Date of revision:
Handle: RePEc:brd:wpaper:31
Contact details of provider: Postal: MS032, P.O. Box 9110, Waltham, MA 02454-9110
Web page: http://www.brandeis.edu/departments/economics/

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  17. W. Braddock Hickman, 1958. "Introduction and Summary of Findings to "Corporate Bond Quality and Investor Experience"," NBER Chapters, in: Corporate Bond Quality and Investor Experience, pages 3-27 National Bureau of Economic Research, Inc.
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  21. Gilson, Stuart C, 1997. " Transactions Costs and Capital Structure Choice: Evidence from Financially Distressed Firms," Journal of Finance, American Finance Association, vol. 52(1), pages 161-96, March.
  22. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
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  24. Avramov, Doron & Chordia, Tarun & Jostova, Gergana & Philipov, Alexander, 2009. "Dispersion in analysts' earnings forecasts and credit rating," Journal of Financial Economics, Elsevier, vol. 91(1), pages 83-101, January.
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