Downgrade/Upgrade Ratio Leads Default Rate

Abstract

Fluctuations in the default rate on high-yield corporate bonds are among the factors that explain variance in the sector's returns. Accordingly, several econometric models have been developed to forecast the default rate. One plausible explanatory variable not normally included is the trend in credit rating changes within the speculative-grade category. The ratio of Moody’s Investors Service's downgrades to upgrades explains approximately one-half to two-thirds of the change in the default rate two to three quarters later.