The Impact of the Rating Agencies' Through‐the‐cycle Methodology on Rating Dynamics

Surveys on the use of agency credit ratings reveal that some investors believe that credit‐rating agencies are relatively slow in adjusting their ratings. A well‐accepted explanation for this perception on rating timeliness is the through‐the‐cycle methodology that agencies use. Through‐the‐cycle ratings are intended to measure default risk over long investment horizons and to respond only to changes in the permanent component of credit quality. A second aspect of the through‐the‐cycle methodology is the prudent migration policy. In a benchmark study with a financial ratio‐based credit‐scoring models – an agency‐rating prediction model and default‐prediction models with various time horizons – we confirm the exclusive focus of agencies on the permanent component of credit quality and we model and quantify the agencies' prudent migration policy. A rating migration is triggered only when the rating predicted by the agency‐rating prediction model differs by at least a threshold level of 1.8 notch steps from the actual agency rating. If triggered, ratings are only partly adjusted by 70 per cent at the downside and 60 per cent at the upside. From a 1‐year point‐in‐time perspective, weighting temporary fluctuations in credit quality, the through‐the‐cycle methodology lowers the rating‐migration probability by a factor of 3.5. Both aspects of the through‐the‐cycle methodology contribute equally to this factor. The partial adjustment of ratings lowers the rating‐reversal probabilities on short term and introduces rating drift, the known serial correlation in agency‐rating migrations.     

Emerging market sovereign bond spreads,credit ratings and global financial crisis

This paper investigates the impacts of sovereign credit ratings and global financial conditions on the evolution of EMBI Global (EMBIG) spreads for a panel of 23 developing countries by using daily data for the period between 1998 and 2012. To this end, we employ not only the conventional panel estimation procedures, but also the recent methods tackling with either cross-sectional dependence stemming from common global shocks or a potential endogeneity. Our results suggest that credit ratings along with global financial conditions re the main determinants of EMBIG spreads. The determinants of EMBIG spreads are not invariant to speculative and investment grade episodes and transitions between them. The recent global crisis changed the determinants of EMBIG spreads and led to credit ratings' impact to converge between speculative and investment grade countries.     

国家主权信用评级、跨国传染与股票市场回应?--基于全球48个经济体的事件研究

掌握主权信用评级变动的市场影响及其传染机制,对于投资者、国家金融安全及政府采取应对措施来说都意义重大。文章采用事件研究法,以1990-2013年全球48个经济体发生的评级事件和每日股指收益率数据为样本,实证研究了事件国评级变动对非事件国股票市场的影响及其传染渠道,结果表明：(1)评级下调会对股票市场产生显著为负的超额收益,但评级上调产生的超额收益不显著;(2)股票市场可以提前预测评级下调事件,但不能预测评级上调事件;(3)季风效应对评级调整的市场传染有一定的解释力;(4)净传染效应基本不显著,这说明评级事件的市场传染应该有经济基础,而不是由投资者心理预期这类非基本面因素造成的;(5)溢出效应可以较好地解释评级的市场传染,是评级变动影响市场及传染的主要渠道。文章的结论深化了我们对评级调整如何影响股票市场及其传染渠道的认识,也为中国防范国外主权信用评级变动风险提供了有益启示。     

Do sovereign rating announcements affect emerging market exchange rate correlations? A multivariate DCC-GARCH approach

This article investigates the effects of sovereign credit rating announcements on time-varying exchange rate return correlations for a sample of 11 emerging market countries over the period 2002–2015. The data set covers daily exchange rates and long-term foreign currency sovereign ratings, outlooks and watch list. The pairwise time-varying correlations are derived by corrected Dynamic Conditional Correlation (cDCC) modelling which is a member of multivariate Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models family. Furthermore, to capture the global factor effect, a dynamic-weighted index is created by using dynamic principal component (DPC) analysis. Findings suggest that some of the emerging market exchange rate co-movements are affected by rating announcements. Upgrades of Moody’s and downgrades of Fitch lead to spillovers. Main source of these spillovers are sovereign credit rating changes of European countries, especially Czech Republic and Turkey. Countries with high amount of external debt, large current account deficit and speculative grade are more prone to be influenced by announcements on a foreign country’s long-term sovereign rating.     

Determinants of the distance between sovereign credit ratings and sub-sovereign bond ratings: Evidence from emerging markets and developing economies

This article explores factors that affect the distance between sovereign credit ratings and the ratings assigned to new foreign-currency bonds issued by sub-sovereign entities (such as private non-financial corporations, financial firms, and public sector enterprises) in 47 emerging markets and developing economies. Censored and double-hurdle regression models are used to estimate the relative contributions of bond-level, issuer-level, and macroeconomic factors that determine this distance, separately for those rated at or below the sovereign rating and those rated above. For the three quarters or more of sub-sovereign bond ratings that are constrained by the sovereign rating ceiling, a Tobit regression model shows a smaller distance – suggesting stronger sovereign–corporate linkages – for public sector enterprises and financial firms relative to other firms. Riskier global financial conditions are also associated with sub-sovereign bonds being rated closer to the sovereign rating. For the small number of sub-sovereign bonds rated higher than the sovereign rating, a double-hurdle model shows that certain debt features – such as bonds backed by future-flow receivables or other collateral or structured as Special Purpose Vehicles (SPV) – significantly raise the likelihood of piercing the sovereign rating ceiling and also increase the distance above the sovereign ceiling.     

PIGS or Lambs? The European Sovereign Debt Crisis and the Role of Rating Agencies

This paper asks whether rating agencies played a passive role or were an active driving force during Europe??s sovereign debt crisis. We address this by estimating relationships between sovereign debt ratings and macroeconomic and structural variables. We then use these equations to decompose actual ratings into systematic and arbitrary components that are not explained by previously observed procedures of rating agencies. Finally, we check whether systematic, as well as arbitrary, parts of credit ratings affect credit spreads. We find that both do affect credit spreads, which opens the possibility that arbitrary rating downgrades trigger processes of self-fulfilling prophecies that may drive even relatively healthy countries towards default.     

Sovereign credit ratings in the European Union: A model-based fiscal analysis

We present a model-based measure of sovereign credit ratings derived solely from the fiscal position of a country: a forecast of its future debt liabilities, and its potential to use fiscal policy to repay these. We use this measure to calculate credit ratings for 14 European countries over the period 1995–2012. This measure identifies a European sovereign debt crisis almost two years before the official ratings of the credit rating agencies.     

主权信用评级与金融安全

本文分析了金融开放条件下主权信用评级波动对金融市场安全的影响和传递机制,探讨了主权信用评级、国际投资银行以及投资者预期等因素在国际金融危机中扮演的角色,并从加强对外资机构在华信用评级业务范围和评级流程的监督管理、推进中国信用评级机构国际化建设、理顺评级过程中所涉各方利益、探索投资者的法律保障等5个方面,就促进中国主权信用评级公正和稳定提出建议。     

Credit ratings and bond spreads of the GIIPS

We examine the relationship between credit ratings and bond yield spreads of peripheral countries in the euro area (Greece, Ireland, Italy, Portugal and Spain) for the period 1995–2014. Since 2012, bond spreads of those countries have come down very fast, whereas credit ratings have hardly changed. Our results suggest that credit rating agencies have become more cautious and have changed their approach to assess credit risk of sovereigns, and that the impact of sovereign credit risk ratings on sovereign bond spreads has changed.     

Sovereign credit ratings,growth volatility and the global financial crisis

Using monthly data from January 1996 to May 2010 for a panel of 76 developed and emerging economies and adopting an instrumental variable (IV) estimation technique by correcting for both heterogeneity and endogeneity with the generalized two-stage least squares (G2SLS, EC2SLS) procedure method suggested by Balestra and Varadharajan-Krishnakumar (1987) and Baltagi and Li (1995), this article provides empirical evidence that volatility of per capita GDP growth is reduced when there are positive changes in credit ratings; in other words when sovereign credit risk improves. To deal with potential simultaneity between sovereign credit ratings and output volatility, a system (3SLS) approach is undertaken, and our findings remain robust. By weakening the volatility dampening effects of ratings changes, it is found that the global financial crisis (GFC) has enhanced macroeconomic volatility. One of the channels via which sovereign rating changes affect growth volatility is the financial markets’ repricing of sovereign default risk that is reflected in sovereign credit default swap (CDS) spreads and its volatility.     

主权信用评级对证券市场的影响研究述评

国际证券市场的持续动荡,使得主权信用评级的影响作用越加突现。诸多研究指出,主权信用评级调整对股票市场和债券市场都存在影响,但由于市场对信息的敏感程度不同,股票市场比债券市场的反应剧烈,而且股票市场对主权信用评级调整能作出提前响应。由于市场预期和经济周期的合力作用,市场存在着对正负评级变化的不对称反应。因此,对现有文献进行梳理和评议,一方面增进了人们对这一问题的认识和理解,另一方面也为制定风险防范政策提供了一定的参考依据。     

Pro-cyclical effect of sovereign rating changes on stock returns: a fact or factoid?

This article examines the effect of changes in sovereign credit ratings and their outlook on the stock market returns of European countries at different phases of business cycle. Using standard four-factor model, it records a significant average marginal effect of credit rating announcements on stock market returns. Both magnitude and significance of the effect vary with business cycle and across announcement types. However, we do not find evidence of pro-cyclical effect of sovereign rating and outlook changes on stock returns. Our results show that stock markets react more negatively to rating downgrades in recovery phases and more positively to rating upgrades in contractionary period. Both results are statistically significant and robust to various sensitivity tests.     

The impact of sovereign risk on bond duration: Evidence from Asian sovereign bond markets

This paper examines the effect of sovereign risk on bond duration. We compare the sovereign risk-adjusted duration for U.S. dollar-denominated Asian sovereign bonds with their Macaulay duration for both investment grade bonds and speculative grade bonds. We find that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for all bonds, regardless of their bond rating and their maturity. Further, the “shortening” effect of sovereign risk on duration gets stronger as bond rating deteriorates and in recessionary conditions. Our findings provide strong support for the importance of adjusting for sovereign risk when bond portfolio managers apply the popular duration measure to hedge interest rate risk.     

Exploring the mismatch between credit ratings and loss-given-default: A credit risk approach

It is commonly observed that high grade loans with better ratings are often associated with low recoveries if they default (i.e. with relatively high loss-given-default (LGD)). To address the mismatch problem, this paper proposes a credit risk approach by minimizing LGD for higher rated loans as a risk-rating matching standard in the sense that the decreasing LGD from creditors’ perspective is associated with higher credit rating for the borrower. This standard forces customers’ credit rating of each grade to be optimally determined in correspondence to its LGD, which means the LGD of high grade loans tends to be low. The approach is then tested using three credit datasets from China, i.e. credit data from 2044 farmers, 2157 small private businesses and 3111 SMEs. The empirical results show that the proposed approach indeed guides the way to solve the mismatch phenomenon between credit ratings and LGDs in the existing credit rating literature. By optimally determining credit ratings, the findings derived from this paper help provide a valuable reference for bankers, and bond investors to manage their credit risk.     

Elections, Opportunism, Partisanship and Sovereign Ratings in Developing Countries

We empirically examine whether and how opportunistic and partisan political business cycle (“PBC”) considerations explain election‐period decisions by credit rating agencies (“agencies”) publishing developing country sovereign risk‐ratings (“ratings”). Analyses of 391 agency ratings for 19 countries holding 39 presidential elections from 1987–2000, initially suggest that elections themselves prompt rating downgrades consistent with opportunistic PBC considerations, that incumbents are all likely to implement election‐period policies detrimental to post‐election creditworthiness. But more refined analyses, integrating both opportunistic and partisan PBC considerations in a unified framework, suggest that election‐period agency downgrades (upgrades) are more likely as right‐wing (left‐wing) incumbents, become more vulnerable to ouster by challengers. Together, these results underscore the importance of integrating both opportunistic and partisan PBC considerations into any explanation of election‐period risk assessments of agencies and, perhaps, other private, foreign‐based financial actors important to the pricing and allocation of capital for lending and investment in the developing world.     

Efficiency and credit rating in Taiwan banking: data envelopment analysis estimation

In this article, we use the data envelopment analysis to measure the efficiency of banks before and after credit rating is taken into consideration and we also employ the Malmquist Productivity Index to measure the total factor productivity changes from 2001 to 2003. The results are as follows: (1) There is a positive relationship between the efficiency scores and credit rating, and thus, the credit rating can be a representative to evaluate the performance and quality of a bank; (2) We use the Wilconxon two-sample test of nonparametric statistic to test the influences of credit rating. The empirical result shows that the credit rating is proven to influence the efficiency of banks; (3) The efficiency scores improve in both investment grade (above tw BBB?) and speculation grade (under tw BBB?), when credit rating is taken into consideration. The empirical results show that the efficiency scores of banks with a high credit rating improved relatively more when compared to banks with a lower credit rating; (4) In this research we also adopt the Malmquist index to observe the productivity and efficiency changes from year to year. We obtain results whereby the improvement of efficiency may be influenced greatly both from pure technical and scale efficiency changes.     

An Empirical Assessment of Sovereign Country Risk in the Black Sea Region

Country risk is recognized as a key factor considered prior to undertaking cross-border economic activity such as an investment or a financial transaction. When the level of country risk is deemed low, commercial and other risks play a more important role in the assessment of the advisability to undertake a cross-border activity. In other cases, country risk levels are significant and may play a decisive role in the assessment of the cross-border activity. By its nature, country risk depends upon perceptions, and as a result both objective measurable factors and subjective issues need to be considered. This study investigates the factors that determine country risk as signalled by a commonly used proxy, the sovereign credit ratings assigned by the major rating agencies. To this end, panel data analysis has been used and applied to three heterogeneous country sub-groups, the Black Sea Economic Cooperation (BSEC) countries, the EU-15, and the Central Europe and Baltic countries, for the period 2004–2013. The results generated suggest that three sets of variables: gross domestic product per capita, debt metrics, and institutional factors, play an instrumental role in explaining country risk across all the sub-groups. However, the individual results for each sub-group provide evidence that sovereign rating agencies focus on particular economic facets of each, and hence, take into account idiosyncratic aspects, structural as well as regional. Therefore, the study also examines those indicators that matter most or have a ‘specific gravity’ in determining sovereign ratings in each country-group, with a particular focus on the BSEC countries.     

Credit Risk Models – Do They Deliver Their Promises? A Quantitative Assessment

We develop a framework to assess the statistical significance of expected default frequency calculated by credit risk models. This framework is then used to analyse the quality of two commercially available models that have become popular among practitioners: KMV Credit Monitor and RiskCalc from Moody's.
Using a unique database of expected default probability from both vendors, we study both the consistency of the prediction and its timeliness. We introduce the concept of cumulative accuracy profile (CAP) that allows to see in one curve the percentage of defaulting companies captured by the models one year in advance. We also use the Miller's information test to see if the models add information to the S&P rating.
The result of the analysis indicates that these models indeed add relevant information not accounted for by rating alone. Moreover, with respect to rating agencies, the models predict defaults more than ten months in advance on average.
(J.E.L.: C52).     

Why Credit Rating Agencies Exist

Although credit rating agencies exist and are important to the capital markets, there remains a question of why they should exist. Two standard theories are that rating agencies correct a problem of information asymmetry and that they de facto regulate investments. These theories do not fully answer the question. This paper suggests an alternative explanation. While rating agencies produce little new information, they sort information available in the credit market. This sorting function is needed due to the large volume of information in the credit market. Sorting facilitates better credit analysis and investment selection, but bond investors or a cooperative of them cannot easily replicate this function. Outside of their information intermediary and regulatory roles, rating agencies serve a useful market purpose even if credit ratings inherently provide little new information. This alternative explanation has policy implications for the regulation of the industry.     

Forecasting Turkey’s Credit Ratings with Multivariate Grey Model and Grey Relational Analysis

The concept of credit rating rooted back to mid-nineteenth century has become one of the most important elements in the world economy together with the globalization period gradually accelerating in the last two decades and increasing the interaction and sensitivity in the international markets. With the globalization and deepening in the financial markets; the effect, reliability and stability of knowledge of the actors who are in charge for directing the global capital flows have quite a big importance in terms of the decisions to be made in the future. In this process, credit rating agencies eliminating the information asymmetry between the countries and institutions who want to create financial resource by borrowing from the savings owners and foreign institutions. Credit ratings determined by the mentioned organizations are accepted as an indicator of the countries to meet the financial obligations in other words their creditworthiness. For Turkey’s economy having a structure with a high level of external financing needs in terms of accelerating the growth and development process, it is inevitable to have an international creditworthiness increasing long-term investment tendency meeting foreign capitals’ trust search. In this study, firstly the determinants of the credit ratings given by credit rating agencies are determined and then forecasting Turkey’s future credit ratings by combining them with multivariate grey model and grey relational analysis are performed.