Credit rating agencies beaten by a spreadsheet

Alex Hern reports on yet more news showing the uselessness of credit ratings agencies

S&P: An infinite number of monkeys?


A spreadsheet with some publicly available accounting and market based information can do a better job at predicting the probability that companies will default than the ratings agency Standard and Poor’s, according to a paper released by economists Jens Hilscher and Mungo Wilson, of Brandeis and Oxford Universities.

Olaf Storbeck of Economics Intelligence reports:

At the core of the paper are corporate bond ratings by Standard & Poor’s. Hilscher and Wilson look at all assessments that have been given between 1986 and 2008.

Additionally, they constructed an alternative indicator that is meant to gauge the default risk of the bond issuers. The economists only use publicly available information for this “failure score”, mainly balance sheet data like profitability, leverage and cash holdings.

The authors conclude (pdf):

We find that this measure… is substantially more accurate than rating at predicting failure at horizons of 1 to 10 years.

The higher accuracy in predicting the cumulative failure probability is driven by a much higher ability of failure score at predicting marginal default probabilities at horizons of up to 2 years and the fact that credit rating adds little information to marginal default prediction at horizons up to 5 years.

In other words:

Ratings are in fact a poor predictor of corporate failure.

See also:

Osborne’s austerity is failing at the one thing it’s supposed to doAlex Hern, February 14th 2012

Credit rating agencies weigh in on independent ScotlandAlex Hern, February 6th 2012

European socialists call for regulation of the ratings agenciesAlex Hern, January 18th 2012

No, Gideon, low gilt yields aren’t good news, and here’s whyCormac Hollingsworth, November 16th 2011

The current crisis: brought to you politician by inaction and unaccountable credit rating agenciesGeorge Irvin, August 8th 2011

  • Pingback: Jose Aguiar()

  • Pingback: Pulp Ark()

  • Pingback: Greg O'Reilly()

  • Pingback: Political Planet()

  • Pingback: robert haigh()

  • Pingback: leftlinks()

  • Pingback: David()

  • Pingback: Owen Williams()

  • Anonymous

    It’s a hindcast, not a forecast.

    Any idiot can fit to past data, but that will invariably work awfully going forward.

    So have they done the same for governments? I doubt it.

    7,000 bn of government debt in the UK when you include all those off balance sheet items hidden from view such as PFI.

    Income 550 bn.

    Not surprising that the UK is going the way of Greece.

  • Pingback: BevR()

  • Anonymous

    The other problem, is that credit ratings are for a 10 year horizon. Unless you run the test for another 5 years, you aren’t assessing the ability of the ratings agencies.

  • Pingback: John Rentoul()

  • Pingback: Michael()

  • Pingback: David O'Leary()

  • Pingback: Mike Bennett()

  • BenM_Kent

    PFI, like pensions, are irrelevant to the government’s debt profile.

    Actually all government debt is irrlevant when you have sovereignty over the issuance of your own currency.

    Your mendacity is transparent.

  • Pingback: BevR()

  • Pingback: J-P Martins()

  • Pingback: AltGovUK()

  • mediantoo

    A Guardian article today obliquely hints at the corruption that is at the core of credit rating agencies. Of course, it doesn’t go far enough. The agencies are colluding with the US financial system, which is why they made the junk fraudulently passed on by banks AAA, and it looks as though they are deliberately interfering in Europe’s economy – which, after all has always been the US goal since the end of WW2 and the Cold War. We may be fortunate that the Russians were contained, but the US continues to influence and milk our economies through finance, etc.

  • Pingback: Alex()

  • Pingback: Socrates()

  • Pingback: Credit Rating Repair()

  • Newsbot9

    Not surprising at all when 1%ers like you are ensuring that your corporate welfare is topped up despite everything else.

    And you can’t “past” the data, so that’s one idiot who can’t.

  • Pingback: Donald van Deventer()

  • Pingback: Martin Zorn()

  • Pingback: Jordan Terry()

  • Pingback: VALUEWALK LLC()

  • Pingback: JS()

  • Anonymous

    Not irrelevant if you have to rely on them for your income.

    I presume you mean they can print. Sure they can. That causes inflation. That means pension payouts go up to match.

    Or is your suggestion that pensioners pay the price for government debts?

  • Newsbot9

    Well, it’s your POLICY that pensions pay the price for the government’s austerity, so…

  • Anonymous

    Pensions pay the price for not using assets to back them. You need to dig back to see the real cause.

    Austerity has arisen because government have been running naked off the book debts. Debts with no assets to match. Off the books because it wasn’t reported in the accounts, and so politicians assumed that the debts are small.

    That’s why you won’t get the promised gold plated pension of yours. They will cut it. The tyranny of the majority. It’s called democracy and you are vulnerable.

  • Pingback: Alexander at odds with Osborne over UK credit rating | Left Foot Forward()