Essays on credit rating agencies and the assessment of sovereign risk

Sovereign ratings have only recently regained attention in the academic debate. This seems to be somewhat surprising against the background that their influence is well-known and that rating decisions have often been criticized in the past (as for example during the Asian crisis in the 90s). Sovereign ratings do not only assess the creditworthiness of governments: They are also included in the calculation of ratings for sub-sovereign issuers whereby their rating is usually restricted to the upper bound of the sovereign rating (sovereign ceiling). Earlier studies have also shown that the downgrade of a sovereign often leads to contagion effects on neighbor countries. This study focuses first on misleading incentives in the rating industry before chapter three summarizes the literature on the influence and determinants of sovereign ratings. The fourth chapter explores empirically how ratings respond to changes in sovereign debt across specific country groups. The fifth part focuses on single rating decisions of four selected rating agencies and investigates whether the timing of decisions gives reason for herding behavior. The final chapter presents a reform proposal for the future regulation of the rating industry in light of the aforementioned flaws.rn

Regulation and the Management of Expectations - Rating Agencies Revisited

In the aftermath of the 2008 crisis, scholars have begun to revise their conceptions of how market participants interact. While the traditional “rationalist optic” posits market participants who are able to process decisionrelevant information and thereby transform uncertainty into quantifiable risks, the increasingly popular “sociological optic” stresses the role of uncertainty in expectation formation and social conventions for creating confidence in markets. Applications of the sociological optic to concrete regulatory problems are still limited. By subjecting both optics to the same regulatory problem—the role of credit rating agencies (CRAs) and their ratings in capital markets—this paper provides insights into whether the sociological optic offers advice to tackle concrete regulatory problems and discusses the potential of the sociological optic in complementing the rationalist optic. The empirical application suggests that the sociological optic is not only able to improve our understanding of the role of CRAs and their ratings, but also to provide solutions complementary to those posited by the rationalist optic.

The credit ratings game

The spectacular failure of top-rated structured finance products has broughtrenewed attention to the conflicts of interest of Credit Rating Agencies (CRAs). We modelboth the CRA conflict of understating credit risk to attract more business, and the issuerconflict of purchasing only the most favorable ratings (issuer shopping), and examine theeffectiveness of a number of proposed regulatory solutions of CRAs. We find that CRAs aremore prone to inflate ratings when there is a larger fraction of naive investors in the marketwho take ratings at face value, or when CRA expected reputation costs are lower. To theextent that in booms the fraction of naive investors is higher, and the reputation risk forCRAs of getting caught understating credit risk is lower, our model predicts that CRAs aremore likely to understate credit risk in booms than in recessions. We also show that, due toissuer shopping, competition among CRAs in a duopoly is less efficient (conditional on thesame equilibrium CRA rating policy) than having a monopoly CRA, in terms of both totalex-ante surplus and investor surplus. Allowing tranching decreases total surplus further.We argue that regulatory intervention requiring upfront payments for rating services (beforeCRAs propose a rating to the issuer) combined with mandatory disclosure of any ratingproduced by CRAs can substantially mitigate the con.icts of interest of both CRAs andissuers.

Credit rating agency regulation after the UK's EU membership referendum

Assesses the implications of the UK's decision to withdraw from the EU for the regulation of its credit rating industry. Discusses the current rules of the Credit Rating Agencies Regulations 2010. Considers how the likelihood that a "post-Brexit" UK will be increasingly dependent on its financial services sector might affect the approach taken towards its regulation.

The universal credit rating group:the viability of a response

The role played by the Big Three credit rating agencies (Standard & Poor’s, Moody’s, and Fitch) in the creation of the recent Financial Crisis has been well documented, as too has their conduct in the aftermath of the Crisis where they contributed to the prolonging of the effects of the systemic breakdown. Also, with a string of record fines and cease-and-desist orders in the wake of the Crisis lending weight to the notion that the Big Three have no plans of performing any more ethically, there are a number of organisations that are endeavouring to provide a better alternative to the stranglehold of the Big Three. In the first instalment of the Viability of a Response series we were introduced to the International Non-Profit Credit Rating Agency who, through the amalgamation of forward-looking and non-profit ideals, intends to inject some much needed ethical consideration into the process of providing ratings that are crucial to the marketplace . In this edition of the series, we will be introduced to the Universal Credit Rating Group (UCRG) which is an alliance between Dagong Global Ratings, RusRating, and Egan-Jones Rating Company. We will start by learning more about this alliance that is due to come into effect in the next few years, and then the article will examine the reality of the situation to come to a conclusion on what the Group’s chances of success may be.

Modell zur Förderung des Wettbewerbs und der Transparenz auf dem Ratingmarkt unter Berücksichtigung der Besonderheiten der deutschen Bankenstruktur

This paper provides a model for the international market of credit ratings in order to promote transparency of rating methodologies and combat the oligopolistic market structure where Standard & Poor‘s, Moody‘s and Fitch Ratings collectively comprise approximately 85 percent of the market. For the German credit market this paper strongly advises the establishment of at least three centralistic credit rating agencies (CRAs), set up and run independently by the large bank institutions – „Großbanken“, „Sparkassen“ and „Genossenschaftsbanken“. By acting as CRAs, universal banks could not only decrease their costs but would also be able to increase competition and transparency. These new credit rating agencies would be subject to the Basel II internal ratings-based (IRB) surveillance standards that go far beyond the Basel II standard approach with its external ratings by the dominating three US-american CRAs. Due to the fact that the new Basle Accord has already been implemented in Europe, this model could be applied all over Europe and possibly even worldwide, assuming the US were to adopt the new capital adequacy rules. This would lead to an increase in the number of CRAs and hence to more competition, as the barriers to entry in the rating industry would not apply to these new institutions because of their expertise in the credit market. The fact that the IRB-criteria already have to be disclosed by law would make the methodologies transparent and subject to approval by national regulators such as the „Bundesanstalt für Finanzdienstleistungsaufsicht“ (BaFin) in Germany. Hence the requirement to set up a new monitoring committee in Europe would become obsolete.

The Effect of Reputation Shocks to Rating Agencies on Corporate Disclosures

This paper explores the effect of credit rating agency’s (CRA) reputation on the discretionary disclosures of corporate bond issuers. Academics, practitioners, and regulators disagree on the informational role played by major CRAs and the usefulness of credit ratings in influencing investors’ perception of the credit risk of bond issuers. Using management earnings forecasts as a measure of discretionary disclosure, I find that investors demand more (less) disclosure from bond issuers when the ratings become less (more) credible. In addition, using content analytics, I find that bond issuers disclose more qualitative information during periods of low CRA reputation to aid investors better assess credit risk. That the corporate managers alter their voluntary disclosure in response to CRA reputation shocks is consistent with credit ratings providing incremental information to investors and reducing adverse selection in lending markets. Overall, my findings suggest that managers rely on voluntary disclosure as a credible mechanism to reduce information asymmetry in bond markets.

The credit ratings game

The collapse of so many AAA-rated structured finance products in 2007-2008has brought renewed attention to the causes of ratings failures and the conflicts of interestin the Credit Ratings Industry. We provide a model of competition among Credit RatingsAgencies (CRAs) in which there are three possible sources of conflicts: 1) the CRA conflictof interest of understating credit risk to attract more business; 2) the ability of issuersto purchase only the most favorable ratings; and 3) the trusting nature of some investorclienteles who may take ratings at face value. We show that when combined, these give riseto three fundamental equilibrium distortions. First, competition among CRAs can reducemarket efficiency, as competition facilitates ratings shopping by issuers. Second, CRAs aremore prone to inflate ratings in boom times, when there are more trusting investors, andwhen the risks of failure which could damage CRA reputation are lower. Third, the industrypractice of tranching of structured products distorts market efficiency as its role is to deceivetrusting investors. We argue that regulatory intervention requiring: i) upfront paymentsfor rating services (before CRAs propose a rating to the issuer), ii) mandatory disclosure ofany rating produced by CRAs, and iii) oversight of ratings methodology can substantiallymitigate ratings inflation and promote efficiency.

Técnicas de rating em contexto de crise no setor bancário português

Dissertação para a obtenção do Grau de Mestre em Contabilidade e Finanças Orientador: Mestre Adalmiro Álvaro Malheiro de Castro Andrade Pereira

O papel das agências de rating e a dívida pública portuguesa

Durante as últimas décadas observou-se o crescimento da importância das avaliações fornecidas pelas agências de rating, sendo este um fator decisivo na tomada de decisão dos investidores. Também os emitentes de dívida são largamente afetados pelas alterações das classificações atribuídas por estas agências. Esta investigação pretende, por um lado, compreender se estas agências têm poder para conseguirem influenciar a evolução da dívida pública e qual o seu papel no mercado financeiro. Por outro, pretende compreender quais os fatores determinantes da dívida pública portuguesa, bem como a realização de uma análise por percentis com o objetivo de lhe atribuir um rating. Para a análise dos fatores que poderão influenciar a dívida pública, a metodologia utilizada é uma regressão linear múltipla estimada através do Método dos Mínimos Quadrados (Ordinary Least Squares – OLS), em que num cenário inicial era composta por onze variáveis independentes, sendo a dívida pública a variável dependente, para um período compreendido entre 1996 e 2013. Foram realizados vários testes ao modelo inicial, com o objetivo de encontrar um modelo que fosse o mais explicativo possível. Conseguimos ainda identificar uma relação inversa entre o rating atribuído por estas agências e a evolução da dívida pública, no sentido em que para períodos em que o rating desce, o crescimento da dívida é mais acentuado. Não nos foi, no entanto, possível atribuir um rating à dívida pública através de uma análise de percentis.

Sovereign Credit Rating Announcements and Equity Market Response: Evidence from the European Markets

This thesis examines the equity market reactions on credit rating announcements. The study covers 12 European countries during the period of 2000-2012. By using an event study methodology and daily collected stock market returns, the impact of the sovereign credit rating announcements to national stock indices is examined. The thesis finds evidence for the rating downgrades having a statistically significant negative effect on the stock markets. This finding is in line with earlier literature (see Brooks, 2004). The paper also discusses whether the changes in the sovereign credit ratings are contagious, anticipated by the market, and persistent. There is some evidence found for the contagion effects in case of downgrades, but not for upgrades. Markets seem to anticipate rating upgrades, but not downgrades. In addition, market´s reaction towards rating announcements seems not to be persistent.

The Informational Value of Corporate Credit Ratings

This thesis examines the quality of credit ratings issued by the three major credit rating agencies - Moody’s, Standard and Poor’s and Fitch. If credit ratings are informative, then prices of underlying credit instruments such as fixed-income securities and credit default insurance should change to reflect the new credit risk information. Using data on 246 different major fixed income securities issuers and spanning January 2000 to December 2011, we find that credit default swaps (CDS) spreads do not react to changes in credit ratings. Hence credit ratings for all three agencies are not price informative. CDS prices are mostly determined by historical CDS prices while ratings are mostly determined by historical ratings. We find that credit ratings are marginally more sensitive to CDS than CDS are sensitive to ratings.