Are Credit Ratings Procyclical?
Bank for International Settlements, Monetary and Economic Department, 2003 - Bank capital - 33 pages
This paper studies the influence of the state of the business cycle on credit ratings. In particular, we assess whether rating agencies are excessively procyclical in their assignment of ratings. Our analysis is based on a model of ratings determination that takes into account factors that measure the business and financial risks of firms, in addition to indicators of macroeconomic conditions. Utilising annual data on all US firms rated by Standard & Poor's, we find little evidence of procyclicality in ratings. By contrast, we find that initial ratings and rating changes exhibit excess sensitivity to the business cycle. The paper offers two explanations of these results.
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AAA-AA actual rating assess assets balance sheet dating BB B CCC business and ﬁnancial business risk CCC-C coefficients countercyclical coverage C4 credit ratings credit risk cyclical measure cyclical variable data set default risk deﬁned discrete growth indicator downgrades economic exhibit excess sensitivity factors financial ratios ﬁnancial risk ﬁnd firm ﬁrst ﬁt Following BLM Graph identiﬁed inﬂuence initial ratings Interest coverage C3 interest coverage variable investment grade likelihood function linear trend ln particular Long-term debt macroeconomic macroeconomic conditions market model estimates market value Market-model beta measures of business NBER recession index negative normal distribution number of observations number of predicted number of rating operating income Operating margin ordered probit model output growth gap Panel positive coefﬁcient probit model based procyclical rating agencies rating categories rating changes ratings and rating real GDP growth reﬂect relative sample speciﬁcations Standard & Poor's Standard error statistical signiﬁcance Table three-year average total debt trend and cycle upgrades