Ratings versus Spreads as Indicators of Price Risk

Vol. 17, No. 4, 2019
Martin Fridson, CFA, Begum Ipek Yavuz, Kai Zhao and Yan Yu

Past comparisons of “market ratings,” or yield spreads over Treasury rates, and letter grades published by credit rating agencies have focused on the two indicators’ respective records in predicting defaults or promptness in reflecting company-specific changes in credit quality. Corporate bond managers who mark to market and are evaluated on the basis of their annual total return, however, care greatly about price sensitivity to market-wide changes in credit risk premiums. Empirical evidence presented in this study indicates that market ratings provide better information on that matter than agency ratings.