Is There a 'Boom Bias' in Agency Ratings?

Forthcoming in Review of Finance; published by Oxford University Press.

59 Pages Posted: 5 Oct 2013 Last revised: 30 May 2015

See all articles by Mark Dilly

Mark Dilly

Catholic University of Eichstaett-Ingolstadt

Thomas Mählmann

Catholic University of Eichstaett-Ingolstadt

Date Written: May 1, 2014

Abstract

Theory predicts rating agencies' incentive conflicts to be stronger in boom periods, thereby leading to biased ratings and a reduced level of rating quality. We empirically investigate this prediction using a large data set of almost 10,000 U.S. corporate bonds, publicly issued between 1990 and 2007. Our main findings are twofold: First, initial ratings appear to be overly optimistic during boom periods when compared to initial bond spread levels or 'incentive-free' benchmark ratings. Second, boom bond ratings are more heavily downgraded and perform poorly in predicting defaults from an ex post perspective. In several robustness checks we show that the observed 'boom bias' is not resulting from changes in credit-worthiness, adjustments in rating standards over time, competitive pressure, or investor demand, but rather from rating agencies' incentive conflicts.

Keywords: Credit ratings, credit risk, conflicts of interest, yield spreads

JEL Classification: G01, G12, G24

Suggested Citation

Dilly, Mark and Mählmann, Thomas, Is There a 'Boom Bias' in Agency Ratings? (May 1, 2014). Forthcoming in Review of Finance; published by Oxford University Press., Available at SSRN: https://ssrn.com/abstract=2336079 or http://dx.doi.org/10.2139/ssrn.2336079

Mark Dilly (Contact Author)

Catholic University of Eichstaett-Ingolstadt ( email )

Auf der Schanz 49
Ingolstadt, D-85049
Germany

Thomas Mählmann

Catholic University of Eichstaett-Ingolstadt ( email )

Auf der Schanz 49
Ingolstadt, 85072
Germany

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