Credit Ratings are Not Reliable in Predicting Corporate Failure

Agencies which provide credit ratings have played very significant roles in the financial markets. In fact, some of their decisions which are not accurate had made headlines in the business news. There are industry experts and regulators who are questioning the reliability and the use of credit rating agencies according to research conducted.

According to Dr. Mungo Wilson, a Lecturer in Financial Economics at University of Oxford, the research they conducted simply proves the truth about the negative comments that the critics have been arguing for many years about the wrong information provided by credit rating agencies. The ratings made by credit agencies are a poor predictor of default probability. It is because the explanation is not very clear about the default probability. Many variations have to be considered in default probabilities and in addition to this the empirical failure rate in the business cycle must be accurately recorded.

Credit ratings are still the instrument widely used to measure the corporate credit quality. And this is being challenged by a paper from Dr. Wilson and Jens Hilscher, Assistant Professor of Finance at Brandeis University.

The paper shows that the information included in the corporate credit ratings are poor predictor of default probability. Dr. Wilson and Jens said that based on their study and research, a simple model which gathers publicly available information which is called ‘failure score’ is a better and more reliable means of predicting default risk. They used data from 1986 to 2008 and compared it with the prediction made by Standard and Poor’s corporate credit ratings and they found out that their method is twice as effective as that of Standard and Poor’s method.

The data gathered demonstrate that firms have the tendency to default in bad times and which may be referred as systematic defaults risk. The data also suggest insight to corporation owners on how they will fare during economic crisis. Dr. Wilson and Jens observed that credit rating agencies merely based their ratings through the cycle instead of considering the effect of the business cycle fluctuations on default probability. This is the reason why their ratings are not reliable and are poor predictors of default.

The researchers made a conclusion that in order to get an accurate measure of default prediction it should be separated from systematic risk. Default prediction data could quickly respond to specific news while systematic risk’s measure could be a mix of aggregate credit conditions and current credit ratings.

Share and Enjoy:
  • Print
  • Digg
  • Sphinn
  • Facebook
  • Mixx
  • Google Bookmarks
  • Blogplay

Related posts on loans for people with bad credit:

  1. A Company’s Credibility is Not in Their Credit Ratings A Company’s Credibility is Not in Their Credit Ratings Agencies that have been announcing corporations’ credit ratings are currently being put into the hot seat by economic experts. These companies have been actively participating in the finance business ever since the United…...
  2. Best Buy Placed on Credit Watch by S&P Best Buy Placed on Credit Watch by S&P Last Wednesday, the shares of Best Buy Co. Inc. fell to 2.55 percent because its corporate credit rating was only one level ahead of the so-called “junk” status. Best Buy, an electronics retailer in…...
  3. Samsung Electronics’ Credit Ratings Advances Samsung Electronics’ Credit Ratings Advances Standard and Poor’s, the global credit rating agency, changed the credit rating of Samsung Electronics to positive last Monday. S&P cited that Samsung’s operating performance improved as a result of its stronger position in the world’s handset…...
  4. Why Credit Cards for People with Bad Credit Ratings Cost More Why Credit Cards for People with Bad Credit Ratings Cost More If you have bad credit score, then you will probably have a tough time finding a company that will offer you with a credit card. However, since there are so…...
  5. How to Get Personal Loans for Individuals with Poor Credit Ratings How to Get Personal Loans for Individuals with Poor Credit Ratings Personal loans for people with bad credit are readily available. You can find several possibilities for those who are usually looking for money that do not have the highest scores available.…...

Filed under: bad creditCreditCredit Scoreline of credit

Like this post? Subscribe to my RSS feed and get loads more!