A Primer on Rating Agencies as Monitors: An Analysis of the Watchlist Period

38 Pages Posted: 5 Mar 2007

See all articles by Christian W. Hirsch

Christian W. Hirsch

University of Frankfurt; Leibniz Institute for Financial Research SAFE

Jan Pieter Krahnen

Faculty of Economics and Business Administration; Leibniz Institute for Financial Research SAFE; Center for Financial Studies (CFS); Centre for Economic Policy Research (CEPR)

Date Written: July 17, 2007

Abstract

In much of the literature, rating agencies are seen as institutions providing informational services to the market. Our paper contributes to this literature by looking closely at the watchlist period, a particularly well-defined monitoring event. We are interested in the evolution of default risk expectations over the watchlist period.

The change in the firm's distance to default, relative to a benchmark group of firms, serves as our metric of market expectations. Using a complete data set of Moody's watchlist operations since 1991, we find that sorting of firms by abnormal change in distance to default only partially explains the rating decision. Since market expectations rely on publicly available information, we conclude that private information plays a role in the eventual rating assignment. Our results provide indirect evidence for an active monitoring role of rating agencies, as recently suggested by Boot, Milbourn, and Schmeits (2006).

Keywords: Credit Rating Agencies, Watchlist, Distance to Default, Rating Actions

JEL Classification: G33, G14, G29

Suggested Citation

Hirsch, Christian W. and Krahnen, Jan Pieter, A Primer on Rating Agencies as Monitors: An Analysis of the Watchlist Period (July 17, 2007). EFA 2007 Ljubljana Meetings Paper. Available at SSRN: https://ssrn.com/abstract=967463 or http://dx.doi.org/10.2139/ssrn.967463

Christian W. Hirsch

University of Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany
+49 69 798 33704 (Phone)
+49 69 798 33901 (Fax)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Jan Pieter Krahnen (Contact Author)

Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 33699 (Phone)
+49 69 798 33901 (Fax)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 30080 (Phone)
+49 69 798 30077 (Fax)

Center for Financial Studies (CFS) ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60629
Germany
+49 69 798 30050 (Phone)
+49 69 798 30077 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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