Stability of credit ratings: The rating agencies' sensitivity to the economic cycle

• Main Author: Patrício, João Manuel dos Santos
• Publication Date: 2022
• Format: Master thesis
• Language: eng
• Source: Repositórios Científicos de Acesso Aberto de Portugal (RCAAP)
• Download full: http://hdl.handle.net/10071/26784
• topic: Credit rating agencies; Rating changes; Volatility of ratings; Stability; Agências de rating; Mudanças de rating; Volatilidade dos ratings; Estabilidade

“Credit Ratings foster the development and smooth functioning of capital markets by providing transparent information and insight to market participants.” S&P Global Ratings information has been a key factor to financial markets over the course of the years, as Credit Rating Agencies have the important role of reducing information asymmetries between firms and investors. Because of the oligopolistic nature of this sector, coupled with a number of questionable positions taken by these agencies, they have been subjected to a high level of scrutiny and criticism. In this dissertation we deepen the investigation regarding the methodology these agencies apply in their business model. As markets crave for stability and fair assessments from CRAs, they claim to have a through-the-cycle approach that focuses on the long-term and individual performance components of each issue they release. Through our research, in which we applied a measure that encapsulates the information in a ratings transition matrix into a single number, RatVol, we find that CRAs are sensitive to business cycle variations. Unfavorable economic conditions yield a large number of downgrades, and recent observations show that agencies tend to be more prone to overreact to the business cycle variations. Their claims of a through-the-cycle methodology seem to be arguable.