Time to change. Rating changes and policy implications

Abstract

The recent financial crisis manifested the criticism to rating agencies of being slow in adjusting their rating to current conditions. This paper examines the timeliness of rating changes and identifies factors which result in ‘stickiness’ of rating actions. Knowledge of the stickiness of rating agencies is a first step in designing a more appropriate rating system. Stickiness is characterized by not adjusting the rating even when a market-based estimate of default probability changes. Extending an econometric model of friction the migration policy is modelled in terms of thresholds which have to be crossed by default probability estimates before an up- or downgrade occurs. Default probability estimates have to change by two notches before the rating agency reacts. The timeliness differs across the rating spectrum and over the years. During periods with high defaults and for low credit quality firms agencies tend to rate more timely.