Credit ratings and credit risk
Jens Hilscher
hilscher@brandeis.edu
Mungo Wilsony
mungo.wilson@sbs.ox.ac.uk
This version: June 2011
Abstract
This paper investigates the information in corporate credit ratings. We examine the
extent to which …rms’credit ratings measure raw probability of default as opposed to
systematic risk of default, a …rm’s tendency to default in bad times. We …nd that credit
ratings are dominated as predictors of corporate failure by a simple model based on
publicly available …nancial information (‘failure score’), indicating that ratings are poor
measures of raw default probability. However, ratings are strongly related to a straight-
forward measure of systematic default risk: the sensitivity of …rm default probability
to its common component (‘failure beta’). Furthermore, this systematic risk measure is
strongly related to credit default swap risk premia. Our …ndings can explain otherwise
puzzling qualities of ratings.
JEL Classi…cation: G12, G24, G33
Keywords: credit rating, credit risk, default probability, forecast accuracy, systematic
default risk
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