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

30 Pages Posted: 26 Mar 2013

See all articles by John Kiff

John Kiff

Satoshi Capital Advisors; Sovereign Official Digital Association (SODA)

Michael Kisser

BI Norwegian Business School

Liliana B. Schumacher

International Monetary Fund (IMF) - Asia and Pacific Department; George Washington University - Department of International Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 2013

Abstract

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.

Keywords: Credit ratings, Credit rating agencies, Credit rating migration

JEL Classification: G20, G24, G28

Suggested Citation

Kiff, John and Kisser, Michael and Schumacher, Liliana, Rating Through-the-Cycle: What Does the Concept Imply for Rating Stability and Accuracy? (March 2013). IMF Working Paper No. 13/64, Available at SSRN: https://ssrn.com/abstract=2239540

John Kiff (Contact Author)

Satoshi Capital Advisors ( email )

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Floor 17
New York, NY New York 10004
United States

Sovereign Official Digital Association (SODA) ( email )

15976 Woodgrove Road
Purcellville, VA 20132
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5714982777 (Phone)

Michael Kisser

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Liliana Schumacher

International Monetary Fund (IMF) - Asia and Pacific Department ( email )

700 19th Street NW
Washington, DC 20431
United States

George Washington University - Department of International Business ( email )

2023 G Street NW
Washington, DC 20052
United States
202-244-3971 (Phone)
202-244-3971 (Fax)

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