Credit Ratings and Credit Risk: Is One Measure Enough?
Brandeis University - International Business School
Mungo Ivor Wilson
University of Oxford - Said Business School
March 7, 2013
AFA 2013 San Diego Meetings Paper
This paper investigates the information in corporate credit ratings from a positive and normative perspective. If ratings are to be informative indicators of credit risk they must reflect what a risk-averse investor cares about: both raw default probability and systematic risk. We find that ratings are inaccurate measures of raw default probability - they are dominated as predictors of failure by a simple model based on publicly available financial information. However, ratings do contain relevant information since they are related to a measure of exposure to common (and undiversifiable) variation in default probability, exposure that is related to CDS risk premia. Given the multidimensional nature of credit risk, it is not possible for one measure to capture all the relevant information. In consequence, ratings may be prone to misinterpretation.
Number of Pages in PDF File: 53
Keywords: credit rating, credit risk, default probability, forecast accuracy, systematic default risk
JEL Classification: G12, G24, G33working papers series
Date posted: September 18, 2009 ; Last revised: March 8, 2013
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