Is There Valuable Private Information in Credit Ratings?
30 Pages Posted: 27 Mar 2020
Date Written: March 3, 2020
Abstract
Credit rating agencies (CRAs) contend their ratings contain a quantitative assessment based on hard information, and a qualitative adjustment based on private information. We study if the qualitative portion of ratings, generated with the companies' own private information, contain valuable information for equity investors. We generate predicted ratings based on hard information alone and form portfolios of stocks based on the difference between observed and predicted rating. Over a sample from 1998 to 2018, we find that stock portfolios formed on the basis of private information generate 2% to 4% in annual risk-adjusted returns. We also find that companies with positive private information have better future accounting performance. Our results suggest that CRAs bring to market valuable information and investors could benefit from it.
Keywords: credit ratings, risk-adjusted returns, credit rating agencies, ratings shopping
JEL Classification: G10
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