The views expressed are those of the authors and do not necessarily reflect those of the Bank of England. We thank Angus Guyatt for outstanding research support. We thank Reza Bahar, Patricia Jackson and other Bank of England colleagues for valuable comments and Angus Guyatt and Steve Grice for research assistance. Copies of working papers may be obtained from Publications Group, Bank of England,

n recent years, the demand for sovereign credit ratings—the risk assessments assigned by the credit rating agencies to the obligations of central governments—has increased dramatically. More governments with greater default risk and more companies domiciled in riskier host countries are borrowing in international bond markets. Although foreign government officials generally cooperate with the agencies, rating assignments that are lower than anticipated often prompt issuers to question the consistency and rationale of sovereign ratings. How clear are the criteria underlying sovereign ratings? Moreover, how much of an impact do ratings have on borrowing costs for sovereigns? To explore these questions, we present the first systematic analysis of the determinants and impact of the sovereign credit ratings assigned by the two leading U.S. agencies, Moody’s Investors Service and Standard and Poor’s. 1 I Such an analysis has only recently become possible as a result of the rapid growth in sovereign rating assign-ments. The wealth of data now available allows us to estimate which quantitative indicators are weighed most heavily in the determination of ratings, to evaluate the predictive power of ratings in explaining a cross-section of sovereign bond yields, and to measure whether rating announcements directly affect market yields on the day of the announcement. Our investigation suggests that, to a large extent, Moody’s and Standard and Poor’s rating assignments can be explained by a small number of well-defined criteria, which the two agencies appear to weigh similarly. We also find that the market—as gauged by sovereign debt yields—broadly shares the relative rankings of sovereign credit risks made by the two rating agencies. In addition, credit ratings appear to have some independent influence on yields over and above their correlation with other publicly available information. In particular, we find that rating announcements have immediate effects on market pricing for non-investment-grade issues.

Internal credit risk rating systems are becoming an increasingly important element of large commercial banks' measurement and management of the credit risk of both individual exposures and portfolios. This article describes the internal rating systems presently in use at the 50 largest US banking organizations. We use the diversity of current practice to illuminate the relationships between uses of ratings, di€erent options for rating system design, and the e€ectiveness of internal rating systems. Growing stresses on rating systems make an understanding of such relationships important for

to be presented at the World Bank,

In this article, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a ‘‘focal point’ ’ for firms and their investors, and explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency (CRA) and a firm through its credit watch procedures. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of rating changes. Credit ratings are quite prevalent in financial markets. Most corporate bond issues have at least one rating, many have two. In fact, the two most prominent rating agencies—Moody’s and Standard & Poor’s (S&P)— adhere to a policy of providing a rating for most taxable corporate bonds publicly issued in the United States. For many observers of the financial markets, credit ratings appear to have real importance. However, the financial economics literature has cast doubt on the importance of ratings.

Regulators, investors, consumers, and insurance brokers use insurer financial strength ratings to evaluate the insolvency risk of insurers. This article investigates the factors influencing the decision to obtain a rating or multiple

Thakor, and seminar participants at the IMF, WorldBank, and Stockholm School of Economics for fruitful discussions and comments. Any remaining errors are our own.

by a working group led by:

Differences of opinion and selection bias in the credit rating industry

Prepared for the Conference on