Do Rating Agencies Deserve Some Credit? Evidence from Transitory Shocks to Credit Risk
69 Pages Posted: 13 Jul 2017 Last revised: 12 Dec 2019
Date Written: December 11, 2019
We find that Credit Rating Agencies (CRAs) see through transitory shocks to credit risk that stem from transitory shocks to equity prices, while market-based measures of credit risk do not. For a given stock return, CRAs are significantly less likely to downgrade firms with transitory shocks than those with permanent shocks. However, credit default swap spreads and model-implied default probabilities do not distinguish between such shocks. These results explain why ratings are useful despite the availability of market-based estimates of credit risk: the ability to ignore transitory shocks is valuable because rating changes have real consequences for private contracts and access to capital.
Keywords: Credit Ratings, Mutual Funds, Institutional Investors, Financial Intermediation
JEL Classification: G14, G23, G24
Suggested Citation: Suggested Citation