Country credit-risk rating aggregation via the separation-deviation model

This article may be used for research, teaching and private study purposes. Any substantial or systematic reproduction, redistribution , reselling , loan or sub-licensing, systematic supply or distribution in any form to anyone is expressly forbidden. The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. The accuracy of any instructions, formulae and drug doses should be independently verified with primary sources. The publisher shall not be liable for any loss, actions, claims, proceedings, demand or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out of the use of this material. Country credit-risk ratings are evaluated independently by several agencies. A common method of aggre-gating the ratings into a single rating is by taking their averages (the averaging method). We show here that an approach that captures the relative ranking of the countries given by each agency leads to an improved aggregate rating with respect to several criteria. The approach we use – the separation-deviation model – was proposed by Hochbaum. We compare the separation-deviation model with the averaging method for aggregating country credit-risk ratings provided by three different agencies. We show that the aggregate rating obtained by the separation-deviation model has fewer rank reversals (discrepancies in the rank ordering of the countries) than the aggregate rating obtained by the averaging method. We further prove several properties of the separation-deviation model, including the property that the aggregate rating obtained by the separation-deviation model agrees with the majority of agencies or reviewers, regardless of the scale used.