Do Credit Rating Agencies Underestimate Liquidity Risk?

Published on July 2016 | Categories: Documents | Downloads: 44 | Comments: 0 | Views: 142
of x
Download PDF   Embed   Report

We test if credit ratings adequately reect liquidity risk, i.e., the risk that the rm may face di-culty in renancing its short-term debt. Consistent with credit ratings underestimating liquidityrisk, we nd that after controlling for credit ratings and other known determinants, long-termbonds of rms with a higher proportion of short-term debt trade at higher yields. Using multi-notch downgrades to identify severe and unexpected rating downgrades, we nd that rms with ahigher proportion of short-term debt are more likely to experience multi-notch downgrades. Theassociation between short-term debt and multi-notch downgrades is stronger in industries thatexperience a negative protability shock, during recessionary periods and when credit conditionsare tight. The relationship is robust to instrumenting the proportion of short-term debt. Overall,our results highlight that rating agencies underestimate liquidity risk, and oer a potential ex-planation for the failure of ratings to predict nancial diculties at rms such as Penn Central,WorldCom, Enron, Bear Stearns and Lehman Brothers.

Comments

Content

We test if credit ratings adequately re
ect liquidity risk, i.e., the risk that the rm may face di-
culty in renancing its short-term debt. Consistent with credit ratings underestimating liquidity
risk, we nd that after controlling for credit ratings and other known determinants, long-term
bonds of rms with a higher proportion of short-term debt trade at higher yields. Using multi-
notch downgrades to identify severe and unexpected rating downgrades, we nd that rms with a
higher proportion of short-term debt are more likely to experience multi-notch downgrades. The
association between short-term debt and multi-notch downgrades is stronger in industries that
experience a negative protability shock, during recessionary periods and when credit conditions
are tight. The relationship is robust to instrumenting the proportion of short-term debt. Overall,
our results highlight that rating agencies underestimate liquidity risk, and oer a potential ex-
planation for the failure of ratings to predict nancial diculties at rms such as Penn Central,
WorldCom, Enron, Bear Stearns and Lehman Brothers.

Sponsor Documents

Or use your account on DocShare.tips

Hide

Forgot your password?

Or register your new account on DocShare.tips

Hide

Lost your password? Please enter your email address. You will receive a link to create a new password.

Back to log-in

Close