Abstract - Can rating agencies look through the cycle?

Rating agencies claim to look through the cycle when assigning ratings, which entails that they are able to separate trend components of default risk from transitory ones. To test whether agencies possess this competence, I take market-based estimates of one-year default probabilities of corporate bond issuers and estimate their long-run trend using the Hodrick- Prescott filter, local regression, or centered moving averages. I find that ratings help identify the current split into trend and cycle. Since the filter methods assume perfect foresight, it can be concluded that rating agencies are indeed able to look through the cycle.

Gunter Löffler
University of Ulm
16.Jan 2007

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