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Are ratings the worst form of credit assessment apart from all the others?


Bloechlinger, Andreas; Leippold, Markus (2017). Are ratings the worst form of credit assessment apart from all the others? Journal of Financial and Quantitative Analysis:Epub ahead of print.

Abstract

We present a prediction model to forecast corporate defaults. In a theoretical model, under incomplete information in a market with publicly traded equity, we show that our approach must outperform ratings, Altman’s Z-score, and Merton’s distance to default. We reconcile the statistical and structural approaches under a common framework, i.e., our approach nests Altman’s and Merton’s approaches as special cases. Empirically, we cannot reject the superiority of our approach.Furthermore, the numbers of observed defaults align well with the estimated probabilities. Finally, with rank transforms, we obtain cycle-adjusted forecasts that still outperform ratings.

Abstract

We present a prediction model to forecast corporate defaults. In a theoretical model, under incomplete information in a market with publicly traded equity, we show that our approach must outperform ratings, Altman’s Z-score, and Merton’s distance to default. We reconcile the statistical and structural approaches under a common framework, i.e., our approach nests Altman’s and Merton’s approaches as special cases. Empirically, we cannot reject the superiority of our approach.Furthermore, the numbers of observed defaults align well with the estimated probabilities. Finally, with rank transforms, we obtain cycle-adjusted forecasts that still outperform ratings.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2017
Deposited On:15 Nov 2016 17:47
Last Modified:02 Jun 2017 19:35
Publisher:Cambridge University Press
ISSN:0022-1090
Related URLs:https://depts.washington.edu/jfqa/2016/06/26/are-ratings-the-worst-form-of-credit-assessment-except-for-all-the-others/ (Publisher)
http://www.efa2012.org/papers/f2h1.pdf
https://orbilu.uni.lu/handle/10993/7791
Other Identification Number:merlin-id:13123

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