The Complementary Nature of Ratings and Market-Based Measures of Default Risk

Agency ratings and market-based measures of default risk are useful complements. Combining the two improves the prediction of defaults over the use of a single measure. While in-sample analysis suggests that one should give more weight to ratings as the horizon increases, or issuers become less risky, a simple equal-weight combination of ratings and market-based measures is hard to beat out of sample. The results suggest that both ratings and market-based measures provide genuine information of their own. TOPICS: Fixed income and structured finance, credit risk management, analysis of individual factors/risk premia