Featured Research

from universities, journals, and other organizations

All credit ratings not created equal: Study shows inflation of credit scores in various asset classes

Date:
September 16, 2011
Source:
Rice University
Summary:
At least one of the "Big Three" credit ratings agencies exaggerated credit scores of private debt compared to public bonds during the last 30 years, according to a new study.

At least one of the "Big Three" credit ratings agencies exaggerated credit scores of private debt compared to public bonds during the last 30 years, according to a new study by researchers from Rice University, American University and Indiana University.

The recent downgrade of U.S. debt by Standard & Poor's makes the study timely, and the research adds to the current debate surrounding regulatory reliance on credit ratings and the current Securities and Exchange Commission proposal to standardize credit ratings across asset classes.

For the study, "Credit Ratings Across Asset Classes: A ≡ A?," business professors John Hund of Rice, Jess Cornaggia of Indiana and Kimberly Cornaggia of American examined credit ratings assigned by Moody's Investors Service from 1980 to 2010. They compared the frequency at which different assets that received the same letter grade defaulted, and they found significant differences. Zero percent of sovereign bonds and .49 percent of municipal bonds that initially received "A" ratings defaulted, compared with 1.83 percent of corporate bonds, 4.9 percent of financial bonds and 27.2 percent of structured bonds.

"Professional investors have been uncertain about the Big Three's ratings similarities, and our findings show that their hesitation is justified," Hund said.

The researchers also found a connection between the rate at which different types of assets had their ratings downgraded or upgraded and the different asset classes. After five years, 27.4 percent of A-rated corporate bonds, 17.8 percent of financial bonds and 33.3 percent of structured bonds were downgraded, versus only 3.3 percent of sovereign bonds and 6.1 percent of municipal bonds.

"Contrary to statements by the Big Three credit raters, our research demonstrates that credit scores are not comparable across asset classes," Hund said. "Debt from different types of issuers with the same ratings has different default rates and different patterns of ratings changes."

The study also shows that municipal and sovereign bonds have been rated more harshly and structured products more generously when compared with traditional corporate bonds. The authors found an inverse correlation between ratings standards and revenue generation among the asset classes.

"We find ratings optimism (leniency or inflation) increases in the revenue generation by asset class," the researchers wrote. "Revenues generated from structured finance products are significantly higher than those generated from corporate issuers which are, in turn, higher than those generated from sovereign issuers and municipalities."

Hund said he hopes that the study will shed new light on the current ratings system and will motivate organizations to do independent research rather than simply rely on what credit agencies are saying.

"In the past several years, some investors have depended on credit agencies to guarantee their decisions as 'safe,' and the current ratings system makes it difficult to determine which are the riskier securities," Hund said. "Ultimately, it's up to investors to know the difference, but the present system of ratings has left many with a false sense of security."

Hund said a consistent ratings system is vital to the future financial health of the United States.

"The foundation of our financial system is understanding credit risk, but we need to re-examine the credit ratings process and the ratings agency's role in that process in order to ensure that the foundation is solid for the future."


Story Source:

The above story is based on materials provided by Rice University. Note: Materials may be edited for content and length.


Journal Reference:

  1. Jess Cornaggia, Kimberly Rodgers Cornaggia, John Hund. Credit Ratings Across Asset Classes: A ≡ A? Social Science Research Network, 2011; [link]

Cite This Page:

Rice University. "All credit ratings not created equal: Study shows inflation of credit scores in various asset classes." ScienceDaily. ScienceDaily, 16 September 2011. <www.sciencedaily.com/releases/2011/09/110915102934.htm>.
Rice University. (2011, September 16). All credit ratings not created equal: Study shows inflation of credit scores in various asset classes. ScienceDaily. Retrieved September 19, 2014 from www.sciencedaily.com/releases/2011/09/110915102934.htm
Rice University. "All credit ratings not created equal: Study shows inflation of credit scores in various asset classes." ScienceDaily. www.sciencedaily.com/releases/2011/09/110915102934.htm (accessed September 19, 2014).

Share This



More Science & Society News

Friday, September 19, 2014

Featured Research

from universities, journals, and other organizations


Featured Videos

from AP, Reuters, AFP, and other news services

The Cost of Ebola

The Cost of Ebola

Reuters - Business Video Online (Sep. 18, 2014) As Sierra Leone prepares for a three-day "lockdown" in its latest bid to stem the spread of Ebola, Ciara Lee looks at the financial implications of fighting the largest ever outbreak of the disease. Video provided by Reuters
Powered by NewsLook.com
U.S. Food Makers Surpass Calorie-Cutting Pledge

U.S. Food Makers Surpass Calorie-Cutting Pledge

Newsy (Sep. 18, 2014) Sixteen large food and beverage companies in the United States that committed to cut calories in their products far surpassed their target. Video provided by Newsy
Powered by NewsLook.com
Stocks Hit All-Time High as Fed Holds Steady

Stocks Hit All-Time High as Fed Holds Steady

AP (Sep. 17, 2014) The Federal Reserve signaled Wednesday that it plans to keep a key interest rate at a record low because a broad range of U.S. economic measures remain subpar. Stocks hit an all-time high on the news. (Sept. 17) Video provided by AP
Powered by NewsLook.com
Some Tobacco Farmers Thrive Amid Challenges

Some Tobacco Farmers Thrive Amid Challenges

AP (Sep. 16, 2014) The South's tobacco country is surviving, and even thriving in some cases, as demand overseas keeps growers in the fields of one of America's oldest cash crops. (Sept. 16) Video provided by AP
Powered by NewsLook.com

Search ScienceDaily

Number of stories in archives: 140,361

Find with keyword(s):
Enter a keyword or phrase to search ScienceDaily for related topics and research stories.

Save/Print:
Share:

Breaking News:
from the past week

In Other News

... from NewsDaily.com

Science News

Health News

Environment News

Technology News



Save/Print:
Share:

Free Subscriptions


Get the latest science news with ScienceDaily's free email newsletters, updated daily and weekly. Or view hourly updated newsfeeds in your RSS reader:

Get Social & Mobile


Keep up to date with the latest news from ScienceDaily via social networks and mobile apps:

Have Feedback?


Tell us what you think of ScienceDaily -- we welcome both positive and negative comments. Have any problems using the site? Questions?
Mobile: iPhone Android Web
Follow: Facebook Twitter Google+
Subscribe: RSS Feeds Email Newsletters
Latest Headlines Health & Medicine Mind & Brain Space & Time Matter & Energy Computers & Math Plants & Animals Earth & Climate Fossils & Ruins