S&P Coupon Bond Ratings and Business Cycles: 1985-2009

Abstract

Many argue that credit rating agencies have perverse incentives to allow the quality of bond ratings to slip, and that this tendency had important implications for the recent market meltdown and ensuing protracted recession. I conduct an empirical study of whether the long-term corporate bond ratings issued by S&P became milder between 1985 and 2009. I use an option-based measure of the probability of firm default as a benchmark against the ratings. I find that the ratings actually became slightly tougher over recent decades. During a typical recession S&P gives softer ratings against the probability of default than during normal economic times. In the expansion between 1991 and 2001, the ratings were more rigorous in the early phase of recovery, but milder in the later phases of expansion. However, during the most recent expansion, from 2001 to 2007, there is little evidence of a slackening of the credit quality standards late in the cycle.