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Predicting Agency Rating Migrations with Spread Implied Ratings

Jianming Kou () and Simone Varotto ()
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Jianming Kou: ICMA Centre, University of Reading

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

Abstract: Investors traditionally rely on credit ratings to price debt instruments. However, rating agencies are known to be prudent in their approach to rating revisions, which results in delayed ratings adjustments to mutating credit conditions. For a large set of eurobonds we derive credit spread implied ratings and compare them with the ratings issued by rating agencies. Our results indicate that spread implied ratings often anticipate future movement of agency ratings and hence could help track credit risk in a more timely manner. This finding has important implications for risk managers in banks who, under the new Basel 2 regulations, have to rely more on credit ratings for capital allocation purposes, and for portfolio managers who face rating-related investment restrictions.

Keywords: credit rating; spread implied rating; credit risk (search for similar items in EconPapers)
JEL-codes: C20 G11 G23 G33 (search for similar items in EconPapers)
Pages: 33 Pages
Date: 2005-06
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