Dror Parnes

Rating the credit rating agencies

ABSTRACT We offer herein several policy tools that can assist the new Office of Credit Ratings within the Securities and Exchange Commission in assessing the quality of past credit ratings and thus measuring the inclusive competency of credit rating agencies. We propose to weigh the degrees of accuracy, consistency and total synchronization between a tested sample of past ratings and a benchmark array of flawless ratings. We also discuss various techniques to handle major discrepancies between these two arrays of credit ratings. We further explain and demonstrate the importance of different sample sizes. In addition, we present a simple approach to estimate the probability of convergence between the two matched sets of ratings under specified governing thresholds. Lastly, we illustrate the bulk of the theory with a concise empirical investigation.

Why Do Bond and Stock Prices and Trading Volume Change around Credit Rating Announcements

It has been well documented that stock prices, bond prices, and trading volume significantly fluctuate around credit rating announcements. Existing literature suggests three alternative theories to rationalize these phenomena. Yet each competing premise can explain only a piece of the puzzle. This study contests these theories and presents a substitute behavioral approach. Our setting leads to a complete and better explanation of the increased trading volume prerating announcement, the significant price movements post-credit announcements, the larger loss post downgrade for low credit categories versus high credit grades, and the stronger loss post downgrade versus gain post upgrade.

The Corporate Acquisition Policy of Financially Distressed Firms

The paper examines a unique motive for corporate acquisitions among distressed firms: the desire to enhance creditworthiness by both the acquirer and the acquired firms. I develop a theoretical model of the creditworthiness conditions necessary for corporate acquisitions and identify the optimal policy in searching for an acquirer. I distinguish between strategic and nonstrategic acquisitions and find the necessary conditions and most favorable policy for a strategic acquisition to evolve. I demonstrate the importance of the cost of finding an acquirer, the impact of sharing bargaining leverage, and the economic significance of credit quality for the success of the accord. Copyright (c) 2009, The Eastern Finance Association.

Applying Credit Score Models to Multiple States of Nature

We conduct a comparative analysis of there popular methodologies; the Z-score, the O-score, and a Cash Flow Based Model-score, in different scenarios constructed from various business conditions and diverse rating classes. We detect dissimilarities in the predictive power of the different models, demonstrate the economic importance, and analyze the sources of this assortment. We find that profitability measurements affect default odds distinctively among different rating categories and within diverse business segments, but cash flow quantities do not. We further deploy a canonical discriminant analysis and propose unique score for the examined states. These alternative scores often challenge the traditional approaches.

Modeling Bankruptcy Proceedings for High-Yield Debt Portfolios

This research assists portfolio managers in estimating expected losses on a portfolio of distressed debt issuances as the predicted costs exclusively associated with bankruptcy filing and default. The pro-posed model conveys high significance among investment managers of non-investment grade debt is-suances, where bankruptcy filing is a real hazard for the underlying assets. We offer simple derivations, general guidelines, and a numerical example for estimating the necessary parameters of the model. Portfolio managers could deploy the formulae within a dynamic code, which can be frequently cali-brated to better identify superior investment strategies and optimize investment performance on high-yield debt issuances.

A Density-Dependent Model for Credit Ratings Migration Dynamics

This study examines an alternative approach for simulating credit ratings migration by associating firms survivability and transitivity to a valuable economic parameter; the market- density. The article contrasts several known methodologies over the S&P long-term credit ratings from 1985 to 2004, and authenticates that the density-dependent model is the most realistic scheme. The proposed model statistically and economically dominates the homogeneous Markov chain process, the stochastic business-cycles notion, as well as the momentum technique in describing credit rating transitions. Its main advantages rely upon simplicity of deployment, and its improved ability to track observed default patterns.

Performance Measurements for Machine-Learning Trading Systems

This study presents several insightful performance measurements for machine-learning trading systems. Machine-learning trading platforms are presumed to operate in a continuous time domain, whereas their learning configurations prompt recurring yet bounded improvements over time. The study provides practical estimation guidelines for the relevant parameters and further illustrates the functionality of the proposed scheme through some conjectural examples. The recommended performance measurements aim to help internal auditors of trading departments and regulatory institutions to better track errors at these automated systems.

Developments in corporate creditworthiness around ownership events

Purpose - This study seeks to explore developments in corporate creditworthiness before and after ownership events. Design/methodology/approach - The paper uses the Blockholders database of Dlugosz, Fahlenbrach, Gompers, and Metrick, and three credit quantities, and deploys a standard event study methodology to examine the relation to corporate creditworthiness. Findings - The paper discovers that ownership-construction is generally associated with prior- and post-improvement in creditworthiness, while a block-destruction is typically surrounded by deterioration in corporate creditworthiness. The paper also finds proper evidence for a relation between the construction or destruction of managerial block and future developments in corporate creditworthiness. The paper further realizes that outside shareholders exhibit higher impact than inside block-holders on later variations in credit risk. Research limitations/implications - The paper is unable to conduct further robustness checks with structural credit methodologies due to the reduced number of valid observations. Originality/value - Market participants can utilize the conclusions to better predict future trends in corporate creditworthiness.

The information content of analysts reports and bankruptcy risk measures

We evaluate the information content of analysts’ reports and bankruptcy risk quantities towards each other, and examine whether differences arise between low- and high-risk firms and between stock recommendations and earnings forecasts. We reveal that past changes in analysts’ reports convey valuable information towards future developments in default risk measures, analysts’ outcome rely upon lagged modifications in corporate creditworthiness, and the predictive power in both directions is more pronounced among high risk enterprises. Furthermore, default likelihoods and analysts’ recommendations and forecasts Granger cause each other, generating a significant feedback system. Moreover, earnings forecasts portray more profound relations to credit risk quantities than stock recommendations.

Observed Leniency among the Credit Rating Agencies

Credit agencies periodically change their ratings for corporate bonds. These rating modifications advance under different circumstances and occur at distinct rates. In this study, the author examines the volumes, frequencies, and likelihoods of credit rating changes as issued by Standard & Poor’s, Moody’s, and Fitch Ratings. He examines these subsequent rating modifications (both the first and the second recorded changes post the initial ratings) with a perspective of upgrades versus downgrades. Overall, he identifies a much greater tendency for rating downgrades than upgrades following new issuance of corporate debt, which suggests that the initial credit ratings are too lenient. This study, therefore, has potential inferences for fixed-income market participants, who should consider discounting reported credit ratings, at least to some degree.