Do Rating Agencies Deserve Some Credit? Evidence from Transitory Shocks to Credit Risk

57 Pages Posted: 13 Jul 2017 Last revised: 16 May 2019

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

Tulane University - A.B. Freeman School of Business

Date Written: May 15, 2019

Abstract

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

Gredil, Oleg and Kapadia, Nishad and Lee, Jung Hoon, Do Rating Agencies Deserve Some Credit? Evidence from Transitory Shocks to Credit Risk (May 15, 2019). 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

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

7 McAlister Drive
New Orleans, LA 70118
United States

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