Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and...
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![Page 1: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/1.jpg)
Access to International CapitalDo the Credit Ratings Agencies Help or Hurt?
Asymmetric Bias and Self-fulfilling Sovereign DefaultsDavid Tennant, Damien King, & Marlon Tracey
![Page 2: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/2.jpg)
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
![Page 3: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/3.jpg)
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.
![Page 4: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/4.jpg)
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
![Page 5: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/5.jpg)
Accuracy costs
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
![Page 6: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/6.jpg)
Under-estimating default likelihood
worse than over-estimatin
g
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
![Page 7: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/7.jpg)
Striking a balance =
over-estimatin
g C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
![Page 8: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/8.jpg)
Optimal over-
estimation worse
the more costly it is
to get informatio
n
C
OS
T
OVER-ESTIMATE UNDER-ESTIMATE
![Page 9: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/9.jpg)
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.
![Page 10: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/10.jpg)
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
![Page 11: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/11.jpg)
Objective of
Statistical Estimatio
n
Test CRAs decision to downgrade, upgrade or leave unchanged the rating of a country’s foreign currency sovereign debt.
![Page 12: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/12.jpg)
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
![Page 13: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/13.jpg)
Data • Countries: 142• Years: 1997 to 2011• CRAs: S&P, Moody’s, Fitch
![Page 14: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/14.jpg)
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
![Page 15: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/15.jpg)
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
![Page 16: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/16.jpg)
Factors Influencin
g Upgrade Threshold
s
S&PMoody’
s FitchLow Income 0.62 0.73 1.14Middle Income 0.08 0.22 0.32
![Page 17: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/17.jpg)
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
![Page 18: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/18.jpg)
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.
![Page 19: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/19.jpg)
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
![Page 20: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/20.jpg)
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
![Page 21: Access to International Capital Do the Credit Ratings Agencies Help or Hurt? Asymmetric Bias and Self-fulfilling Sovereign Defaults David Tennant, Damien.](https://reader034.fdocuments.in/reader034/viewer/2022051417/5697c0191a28abf838cce6a8/html5/thumbnails/21.jpg)
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