Predicting credit rating changes conditional on economic strength

Abstract

This paper develops a new structural model for predicting credit rating changes using firms’ accounting data in a regime-switching multinomial logistic regression analysis. The empirical analysis indicates that the probabilities of upgrade, downgrade, or no-change, are asymmetric across economic regimes. The asymmetry of credit rating changes between the high and low credit-rated firms appears to be significantly different. While high credit-rated firms’ upgrade probabilities do not differ in expansions and contractions, low credit-rated firms’ upgrade probabilities are significantly asymmetric in expansions and contractions. Furthermore, the probabilities of downgrade appear to be asymmetric in expansions and contractions for most of the credit rating levels.