THE IMPORTANCE AND SUBTLETY OF CREDIT RATING MIGRATION

Bond ratings are usually first assigned by rating agencies to public d ebt at the time of issuance and are periodically reviewed by the ratin g companies. If deemed warranted, changes in ratings are assigned afte r the review. A change in a rating reflects the agency's assessment th at the company's credit quality has improved (upgrade) or deteriorated (downgrade). A coincident effect, in some proximity to the date of th e rating change, is a change in the price of the issue. This article r eports on an in-depth investigation of the expected ratings changes (d rift) over time. Our analysis compares rating changes from the two maj or agencies, Moody's and S&P, over the period 1970-1996. For the first time, results from several studies which have documented and analyzed these data patterns are contrasted. Depending upon which study one us es, the results and implications can be very different. We expect that the findings will have implications for such diverse practitioners as bond investors who concentrate on any or all segments of the corporat e bond market, eg., high yield bond and ''crossover'' investors, mark- to-market analysts, and traders in the new and growing market for cred it-risk-derivatives and for the many analysts who properly view that c redit quality assessment involves the entire spectrum of possible outc omes, not just default. A follow-up study will analyze, in greater dep th, two critical characteristics of the rating drift phenomenon. These are unexpected, as well as expected, rating migration patterns and al so the implied impact on the price of the fixed income instrument. (C) 1998 Published by Elsevier Science B.V. All rights reserved.