External Credit Ratings
Year: 2021
Type: preprint
Abstract: It is well known that credit ratings agencies (CRAs) are a key component of financial markets. But it is less well understood that its decisions reach far beyond the financial system boundaries, and have a direct impact in our daily lives. But, how is that so? If CRAs are important in the functioning of financial markets, why are they criticized?
The aim of this study guide is to answer these questions as well as some other relevant issues, such as the main uses of a credit rating and the measurement of its performance, by giving a broad overview of the working of CRAs. As such, it can be used by practitioners as well as students with a background in finance or business.
The study guide is organized as follow: Section 1 explains the basics of CRAs, defining what a credit rating is as well as what it is not intended to signal, its principal uses, the role it plays in financial markets, the different scales to assess the creditworthiness of an issuer, and how default is defined. Section 2 focuses on the concept of country ceiling. It begins by explaining sovereign ratings, then describes country ceiling in global scale and local scale, and explains the relationship between country ceiling and sovereign rating. Section 3 examines the default tables produced by CRAs, and defines the following: cumulative default probability, conditional and unconditional probability of default, and probability of survival. Then it explains the main uses and abuses of default tables. It ends with the important distinction between Rating Point in Time and Rating Through the Cycle. Section 4 describes the methodology used by CRAs to assess the creditworthiness of a corporate issuer. Section 5 presents the following criticisms against CRAs: conflicts of interest, inflation ratings, and opacity in their methodologies. Section 6 finishes by explaining how to measure the performance of credit ratings, and the tension between stability and accuracy.
Source: SSRN Electronic Journal
Author: Sergio Benavente
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3147890841