Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and...
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Transcript of Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and...
Access to International CapitalDo the Credit Ratings Agencies Help or Hurt?
Asymmetric Bias and Self-fulfilling Sovereign DefaultsDavid Tennant, Damien King, & Marlon Tracey
Paper argues that…
• CRAs have reason to be biased against poor countries• Evidence suggests the bias is statistically significant• The bias can be sufficient to trigger default/restructuring
Credit Rating
Agency’s Objective
CRAs wish to minimize both cost (of acquiring information) and inaccuracy (of their ratings).But there is a trade-off between the two, since accuracy is costly.
Characteristics of the
Ratings Business
• It is costly to acquire information on the ability/willingness of a sovereign to service debt• The weaker a country’s
institutions, the poorer it is and also the worse is the quality of readily available information• Default by a highly rated
sovereign is worse (reputationally) than failure to default by a poorly rated one
Accuracy costs
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
Under-estimating default likelihood
worse than over-estimatin
g
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
Striking a balance =
over-estimatin
g C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
Optimal over-
estimation worse
the more costly it is
to get informatio
n
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
Therefore…
• CRA’s estimated probability of default has a bias, the strength of which is inversely related to a country’s level of development.• “Bias” because it is independent of the fundamentals that determine a country’s ability and willingness to repay its debt.
Paper argues that…
• CRAs have reason to be biased against poor countries• Evidence suggests the bias is statistically significant• The bias can be sufficient to trigger default/restructuring
Objective of
Statistical Estimatio
n
Test CRAs decision to downgrade, upgrade or leave unchanged the rating of a country’s foreign currency sovereign debt.
Statistical testing
takes account
of…
• Economic and institutional fundamentals• Debt, debt service, fiscal balance, GDP,
investment, reserves, inflation, CA balance, Institutional quality
• Country specific fixed effects• Some element of a country’s risk may be
particular to that country, e.g., social capital
• Heterogeneous thresholds• Threshold for re-grade not same for all
countries• Time-period dummies• Willingness to re-grade changes over
time• Tempering• General reluctance to change a rating
due to desire for stability and upper/lower limits
Data • Countries: 142• Years: 1997 to 2011• CRAs: S&P, Moody’s, Fitch
Mean Ratings
Low Middle Upper
S&P 8.3 10.2 17.71.89 3.26 3.14
Moody’s 8.4 10.3 17.8
2.21 3.25 3.22
Fitch 8.3 10.4 18.02.26 3.37 3.10
Factors Influencing Ratings Changes
S&PMoody’
s Fitch∇ Debt -5.89 -2.47 -5.76∇ Debt Service 1.98 0.83 -3.43
∇ Real GDP per cap 0.09 0.07 0.08∇ Investment 3.65 5.11 5.71
∇ ln Export 2.67 1.52 0.34
∇ Reserve/Import 0.11 0.09 0.02
∇ Current Account Bal. -6.84 -2.67 -4.41
∇ Inflation -3.99 -0.45 -2.51
∇ Institutional Quality 1.11 1.07 2.14
Factors Influencin
g Upgrade Threshold
s
S&PMoody’
s FitchLow Income 0.62 0.73 1.14Middle Income 0.08 0.22 0.32
Paper argues that…
• CRAs have reason to be biased against poor countries• Evidence suggests the bias is statistically significant• The bias can be sufficient to trigger default/restructuring
Government’s
Objective
Governments wish to minimize both taxes and defaults.But there is a trade-off between the two since they are alternative means of financing.
Characteristics of Fiscal
Choices
• Defaulting is policy choice• There is a fixed cost to defaulting• CRAs can see when a government would be better off by defaulting
default,
default
no default,
default
not default
If CRAsexpectthen
govt should…
To beor not to
be (a defaulter)
not default
then govt should…
y
x
Conclusions
• Optimal for CRAs to overestimate the probability of default• Information acquisition costlier with poorer
countries• Highly rated default is reputationally worse
than a poorly rated survivor• Constitutes a bias• Unrelated to ability and willingness to pay.
• Evidence that S&P, Moody’s, and Fitch are reluctant to upgrade poorer countries
• There is a range of debt where a CRA could rationally predict either default or no default
• Within that range, poor countries are more likely to get an unwarranted lower rating, which can trigger a decision to default