Estimating Unobserved Soft Adjustment in Credit Rating Models: Before and after the Dodd

Estimating Unobserved Soft Adjustment in Credit Rating Models: Before and after the Dodd–Frank Act

Published:2022-07-09 Issue: Volume: Page:
ISSN:1479-8409
Container-title:Journal of Financial Econometrics
language:en
Short-container-title:

Author:

Gu Zhutong¹^ORCID,Jiang Yixiao²^ORCID,Yang Shuyang³

Affiliation:

1. Peking University, HSBC Business School, China

2. Department of Economics, Christopher Newport University, USA

3. Tencent Inc, China

Abstract

Abstract Credit Rating Agencies (CRAs) adjust preliminary bond ratings with knowledge beyond publicly available information. These unobserved “soft adjustments” may reflect material nonpublic information and rating biases due to conflicts of interest, making certain bond characteristics endogenous. We model and quantify soft adjustments as bond-specific thresholds in a semiparametric ordered-response model and exploit ownership structures of bond-issuers to control for endogeneity. Relying on the shift restrictions, we develop a location estimator for models of ordered choices with correlated heterogenous thresholds. Using Moody’s initial ratings from 2000 to 2016, we find a significant reduction of soft adjustment after the Dodd–Frank reform.

Publisher

Oxford University Press (OUP)

Subject

Economics and Econometrics,Finance

Link

https://academic.oup.com/jfec/advance-article-pdf/doi/10.1093/jjfinec/nbac024/44753672/nbac024.pdf

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