Procyclical Credit Rating Policy

65 Pages Posted: 22 Mar 2015

See all articles by Jun Kyung Auh

Jun Kyung Auh

Georgetown University - Department of Finance

Date Written: January 20, 2015

Abstract

This paper studies whether credit rating agencies applied consistent rating standards to U.S. corporate bonds over the expansion and recession periods between 2002 and 2011. Based on estimates of issuing firms’ credit quality from a structural model, I find that rating standards are in fact procyclical: ratings are stricter during an economic downturn than an expansion. As a result, firms receive overly pessimistic ratings in a recession, relative to during an expansion. I further show that a procyclical rating policy amplifies the variation in corporate credit spreads, accounting for, on average, 11 percent of the increase in spreads during a recession. In the cross section, firms with a higher rollover rate of debt, fewer alternative channels to convey their credit quality to the market, and firms that are more sensitive business to economic cycles are more affected by the procyclical rating policy.

Keywords: Credit Rating Policy, Business Cycle

JEL Classification: G24, G28

Suggested Citation

Auh, Jun Kyung, Procyclical Credit Rating Policy (January 20, 2015). Georgetown McDonough School of Business Research Paper No. 2581738. Available at SSRN: https://ssrn.com/abstract=2581738 or http://dx.doi.org/10.2139/ssrn.2581738

Jun Kyung Auh (Contact Author)

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States

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