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Arm's Length Method for Comparing Rating Scales

24 Pages Posted: 18 Apr 2012  

Richard Nabil Hainsworth

RusRating

Vasily M. Solodkov

National Research University Higher School of Economics

Alexander Karminsky

National Research University Higher School of Economics

Date Written: April 17, 2012

Abstract

Investors are being encouraged after the global crisis to reduce their dependence on the largest credit rating agencies for risk assessments of companies and securities. Comparing risk assessments from different sources rapidly becomes non-trivial when more than three credit rating agencies are involved. We propose a method for comparing rating scales, and hence constructing correspondence diagrams and tables, thereby treating the rating scales used by different agencies as objects of study. Scales are compared by looking at sets of ratings assigned to similar entities (in this case banks) with the assumption that the risk being measured by each credit rating agency is the same for a given rated entity at a given point in time. Two ratings assigned by two credit rating agencies may differ for two reasons: the two agencies have different opinions about the relative positioning of the rated entity (e.g., issuer or security) with respect to the universe of other rated entities; both agencies position the rated entity with respect to the universe of other rated entities in the same way, but they use different symbols to represent this position. Type 1 differences should disappear when a large number of ratings are considered. The existence of type 2 differences will require a mapping from one rating scale to another. Studying international bank ratings for a five-year period shows that there are type 2 differences for the largest credit rating agencies. A mechanism for constructing mappings between scales could lead to more competition with new credit rating agencies.

Keywords: rating, rating scale, comparing, mapping, financial risk regulation

JEL Classification: G21, G24, G32

Suggested Citation

Hainsworth, Richard Nabil and Solodkov, Vasily M. and Alexander Karminsky, Arm's Length Method for Comparing Rating Scales (April 17, 2012). Higher School of Economics Research Paper No. WP BRP 01/FE/2012. Available at SSRN: https://ssrn.com/abstract=2041820 or http://dx.doi.org/10.2139/ssrn.2041820

Richard Hainsworth

RusRating ( email )

Serebryakova Proezd 6
Moscow 129343
Russia

Vasily Solodkov

National Research University Higher School of Economics ( email )

Myasnitskaya street, 20
Moscow, Moscow 119017
Russia
+7 095 928 2094 (Phone)

HOME PAGE: http://www.hse.ru

Alexander Karminsky (Contact Author)

National Research University Higher School of Economics ( email )

Myasnitskaya street 20
Moscow, Moscow 119017
Russia

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