Procyclicality of credit rating systems: how to manage it

Tatiana Cesaroni

No 109, Mo.Fi.R. Working Papers from Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences

Abstract: The recent Eurozone financial crisis has highlighted the need for stable rating systems to assess portfolio banks risks exposures abstracting from the current cyclical conditions. This paper evaluates the characteristics of a Point in Time (PiT) rating approach for the estimation of firms' credit risk in terms of pro-cyclicality. To this end I first estimate a logit model for the probability default (PD) of a set of Italian non financial firms during the period 2006-2012, then, in order to address the issue of the rating stability (rating changes hedging) during the financial crisis, I study the effectiveness of an ex post PDs smoothing in terms of obligors' migration among rating risk grades. As bi-product I further discuss and analyze the role played by the rating scale definition (choice) in producing ratings stability. The results show that an ex post PD smoothing is able to remove business cycle effects on the credit risk estimates and to produce a mitigation of obligors' migration among risk grades over time. The rating scale choice also has a significant impact on the rating stability. These findings have important policy implications in banking sector practices in terms of financial system stability.

Keywords: PiT rating system; business cycle; financial stability; long run probability default; procyclicality (search for similar items in EconPapers)
Pages: 32
Date: 2015-07
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (7)

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Journal Article: Procyclicality of credit rating systems: How to manage it (2015)
Working Paper: Procyclicality of credit rating systems: how to manage it (2015)
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