Credit ratings are commonly used by lenders to assess the default risk, because every credit is connected with a possible loss. If the probability of a default is above a certain threshold, a credit will not be provided. The purpose of this paper is to test whether credit ratings contribute valuable information on the creditworthiness of firms. Employing a large sample of Western German manufac...

In the light of Basel II, redesigning rating systems has been becoming an important issue for banks and other financial institutions. The available data base for this task typically contains only the accepted credit applicants and is thus censored. To evaluate existing and alternative rating systems, we would actually need the full data base of all past credit applicants. In this paper we discu...

Rating agencies are often criticized for being biased in favor of borrowers, for being too slow to downgrade following credit quality deterioration, and for being oligopolists. Based on a model that takes into account the feedback effects of credit ratings, I show that: (i) rating agencies should focus not only on the accuracy of their ratings but also on the effects of their ratings on the pro...

We show that sovereign debt impairments can have a significant impact on financial markets and real economies through a credit ratings channel. Specifically, we find that firms reduce their investment and reliance on credit markets due to a rising cost of debt capital following a sovereign rating downgrade. We identify these effects by exploiting exogenous variation on corporate ratings due to ...

During the recent credit crisis credit rating agencies (CRAs) became increasingly lax in their rating of structured products, yet increasingly stringent in their rating of corporate bonds. We examine a model in which a CRA operates in both the market for structured products and for corporate debt, and shares a common reputation across the two markets. We find that, as a CRA’s reputation becomes...

In one case Charles River Associates has dealt with, the tax authority asserted that a subsidiary is of such strategic importance to the group’s ultimate parent company that the subsidiary’s “stand-alone” credit rating should be adjusted upwards to the parent’s rating due to implicit support. This is despite the fact that an explicit guarantee had not been provided by the parent and despite the...

Could inflated credit ratings that provide new information have adverse ex-ante real effects? If so, why? In a debt-rollover game featuring a feedback loop, we show that when the risky projects have high upside returns, the credit rating agency’s (CRA) ex-ante real effects are negative, despite of its positive informational effects. This arises from the CRAs feedback effects: it strategically a...

Monounireducible nonhomogeneous semiMarkov processes are defined and investigated. The monounireducible topological structure is a sufficient condition that guarantees the absorption of the semi-Markov process in a state of the process. This situation is of fundamental importance in the modelling of credit rating migrations because permits the derivation of the distribution function of the time...