Can rating agencies look through the cycle?

Gunter Löffler ()

Review of Quantitative Finance and Accounting, 2013, vol. 40, issue 4, 623-646

Abstract: Rating agencies claim to look through the cycle when assigning corporate credit ratings, which entails that they are able to separate trend components of default risk from transitory ones. To test whether agencies possess this competence, I take market-based estimates of 1-year default probabilities of corporate bond issuers and estimate their long-run trend using the Hodrick-Prescott filter, local regression, or centered moving averages. I find that ratings help identify the current split into trend and cycle. In addition, rating stability is similar to the one of hypothetical ratings based on long-term trends. The results are robust to the use of different filter techniques. They are confirmed by a model-free analysis, which shows that ratings predict future changes in market-based default probability estimates. Since the examined trends are forward-looking in the sense that the trend filtering algorithms use future data, agency ratings exhibit important characteristics one would expect from ratings that see through the cycle. Copyright Springer Science+Business Media, LLC 2013

Keywords: Default risk; Credit ratings; Through-the-cycle; Hodrick-Prescott filter; Merton model; G20; G33 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://hdl.handle.net/10.1007/s11156-012-0289-9 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:rqfnac:v:40:y:2013:i:4:p:623-646

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/11156/PS2

DOI: 10.1007/s11156-012-0289-9

Access Statistics for this article

Review of Quantitative Finance and Accounting is currently edited by Cheng-Few Lee

More articles in Review of Quantitative Finance and Accounting from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().