Credit Ratings and Credit Risk: Is One Measure Enough?

Jens Hilscher and Mungo Wilson ()
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Mungo Wilson: Saıd Business School and Oxford-Man Institute, University of Oxford, Oxford OX1 1HP, United Kingdom

Management Science, 2017, vol. 63, issue 10, 3414-3437

Abstract: This paper investigates the information in corporate credit ratings. If ratings are to be informative indicators of credit risk, they must reflect what a risk-averse investor cares about: both raw default probability and systematic risk. We find that ratings are relatively inaccurate measures of raw default probability—they are dominated as predictors of failure by a simple model based on publicly available financial information. However, ratings do contain relevant information since they are related to a measure of exposure to common (and undiversifiable) variation in default probability (“failure beta”). Systematic risk is shown to be related to joint default probabilities in the context of the Merton [Merton RC (1974) On the pricing of corporate debt: The risk structure of interest rates. J. Finance 29(2):449–470] model. Empirically, it is related to credit default swap spreads and risk premia. Given the multidimensional nature of credit risk, it is not possible for one measure to capture all the relevant information.

Keywords: credit rating; credit risk; default probability; forecast accuracy; systematic default risk (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (49)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:63:y:2017:i:10:p:3414-3437

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