Does the Local Rating Agency Provide ReliableCredit Ratings? An Empirical Analysis from an Emerging Market

Abstract

In this article, the authors use both the stochastic frontier model (Battese and Coelli [1995]) and the discrete-time hazard model (DHM; Shumway [2001]) to determine whether the Taiwan Corporate Credit Risk Index (TCRI) is a good credit risk proxy for companies in Taiwan. They first apply the stochastic frontier model to study the relationship between the TCRI and technical inefficiency and then employ the DHM to study the relationship between the TCRI and financial distress. Finally, they compare the financial distress prediction performance of the DHM using the panel dataset solely based on the TCRI with that based on the well-known predictors in each of Altman [1968], Campbell, Hilscher, and Szilagyi [2008], Duffie, Saita, and Wang [2007], and Shumway [2001]. Their empirical results show that the larger the value of the TCRI, the lower the technical efficiency of the company and the larger the financial distress probability. Also, with the expanding rolling window approach, the DHM employing the panel dataset solely based on the TCRI has the best financial distress prediction performance among the five panel datasets, in the sense of yielding more accurate out-of-sample predicted number of financial distresses. Based on these empirical results, they conclude that the TCRI is a good credit risk proxy for companies in Taiwan.