Rating Through-the-Cycle: What does the Concept Imply for Rating Stability and Accuracy?

By John Kiff, Michael Kisser, Liliana B Schumacher

March 8, 2013

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Format: Chicago

John Kiff, Michael Kisser, and Liliana B Schumacher. Rating Through-the-Cycle: What does the Concept Imply for Rating Stability and Accuracy?, (USA: International Monetary Fund, 2013) accessed November 8, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Credit rating agencies face a difficult trade-off between delivering both accurate and stable ratings. In particular, its users have consistently expressed a preference for rating stability, driven by the transactions costs induced by trading when ratings change frequently. Rating agencies generally assign ratings on a through-the-cycle basis whereas banks' internal valuations are often based on a point-in-time performance, that is they are related to the current value of the rated entity's or instrument's underlying assets. This paper compares the two approaches and assesses their impact on rating stability and accuracy. We find that while through-the-cycle ratings are initially more stable, they are prone to rating cliff effects and also suffer from inferior performance in predicting future defaults. This is because they are typically smooth and delay rating changes. Using a through-the-crisis methodology that uses a more stringent stress test goes halfway toward mitigating cliff effects, but is still prone to discretionary rating change delays.

Subject: Asset valuation, Credit ratings, Credit risk, Debt default, Personal income tax

Keywords: TTC approach, TTC rating, WP

Publication Details

Pages:

29
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2013/064
Stock No:

WPIEA2013064
ISBN:

9781475552119
ISSN:

1018-5941

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