Assessment of Credit Ratings and Credit Risk Models on Public Bonds

Abstract

We investigate the performance of two different credit risk models, the credit ratings of S&P and the market-based credit risk models of Bloomberg, using 12,679 new corporate bonds issued by 933 firms through public offerings in the United States over the 1999–2015 period. In particular, we divide our sample into bonds issued by financial firms and those issued by non-financial firms, and find that (1) even though both the S&P ratings and the Bloomberg models affect the yield spreads significantly, the former has more statistical power in determining the yield spreads; (2) bond ratings of financial firms are higher than those of non-financials, but financial firms pay a higher cost of debt than non-financial firms; (3) S&P credit ratings are superior to Bloomberg models in predicting actual default of the bonds; and (4) financial firms are less likely to default than non-financial firms.

TOPICS: Credit risk management, information providers/credit ratings, fixed income and structured finance, performance measurement

Key Findings

• ▪ S&P’s ratings are better than Bloomberg models in determining the yield spreads.

• ▪ S&P’s ratings are superior to Bloomberg models in predicting the actual default of bonds.

• ▪ Financial firms are less likely to default than non-financial firms.