On the information content of credit ratings and market-based measures of default risk

86 Pages Posted: 13 Jul 2017 Last revised: 20 Jul 2022

See all articles by Oleg Gredil

Oleg Gredil

Tulane University - A.B. Freeman School of Business

Nishad Kapadia

Tulane University - Finance & Economics

Jung Hoon Lee

Vanderbilt University - Finance

Date Written: July 7, 2022

Abstract

We examine the ability of ratings and market-based measures to predict defaults. Although market-based measures are more accurate at horizons up to one year, ratings complement market-based measures and are not redundant in predicting defaults across horizons. Market-based measures differ from ratings in that they respond to both cash-flow and discount-rate news, while ratings respond primarily to cash-flow news, which is more informative of future defaults. Ratings ignore transitory shocks to credit risk, while market-based measures do not. Rating agencies respond to transitory shocks with watches rather than downgrades. Ratings are more informative during expansions and for speculative grade firms.

Keywords: Credit Ratings, Mutual Funds, Institutional Investors, Financial Intermediation

JEL Classification: G14, G23, G24, G32, G33, G38

Suggested Citation

Gredil, Oleg and Kapadia, Nishad and Lee, Jung Hoon, On the information content of credit ratings and market-based measures of default risk (July 7, 2022). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2998242 or http://dx.doi.org/10.2139/ssrn.2998242

Oleg Gredil (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Nishad Kapadia

Tulane University - Finance & Economics ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-7454 (Phone)

Jung Hoon Lee

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
8123603309 (Phone)

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