Are Ratings the Worst Form of Credit Assessment Apart from All the Others?

62 Pages Posted: 28 Feb 2012 Last revised: 27 Jun 2016

See all articles by Andreas Bloechlinger

Andreas Bloechlinger

Zurich Cantonal Bank

Markus Leippold

University of Zurich - Department of Banking and Finance; University of Zurich - Faculty of Economics, Business Administration and Information Technology

Date Written: February 22, 2012

Abstract

We present a prediction model to forecast corporate defaults. In a theoretical model, under incomplete information in a market with publicly traded equity, we show that our approach must outperform ratings, Altman’s Z-score, and Merton’s distance to default. We reconcile the statistical and structural approaches under a common framework, i.e., our approach nests Altman’s and Merton’s approaches as special cases. Empirically, we cannot reject the superiority of our approach.Furthermore, the numbers of observed defaults align well with the estimated probabilities. Finally, with rank transforms, we obtain cycle-adjusted forecasts that still outperform ratings.

Keywords: credit rating agencies, distance to default, z-score, zeta-score, default prediction

JEL Classification: G01, G18, G24

Suggested Citation

Bloechlinger, Andreas and Leippold, Markus, Are Ratings the Worst Form of Credit Assessment Apart from All the Others? (February 22, 2012). Swiss Finance Institute Research Paper No. 12-09. Available at SSRN: https://ssrn.com/abstract=2012277 or http://dx.doi.org/10.2139/ssrn.2012277

Andreas Bloechlinger

Zurich Cantonal Bank ( email )

Josefstrasse 222
Zurich CH-8010, 8005
Switzerland

Markus Leippold (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

University of Zurich - Faculty of Economics, Business Administration and Information Technology ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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