CRA laggards and a Downgrade without Macroeconomic Evidence
Cantor and Packer (1996) made a model (the FLS model) predicting sovereign rating changes based on preceding macroeconomic variables (usual- GDP, growth, inflation, deficit, CA, Debt) that proved robust when replicated by other authors in later timeframes and country data, proving that ratings don't give us any new information that everyone already didn't know. Mora (2005) added financial factors (country's spread on Eurobonds and its past default history) to the model and sought to ask "Do ratings change quickly enough when situations change?
∆Ratingi,t = α + βerrori,t–1 + εi,t
Here, the actual change in a country’s rating from mid-year to next is regressed on a one-year lagged error term-which is the change in predicted ratings from the FLS+financial factors model. Beta was proved to be positive (significant at the 1% level).
The problem here is that not only do the credit rating agencies (CRAs) stubbornly stick to their guns, their analysis is sufficiently basic and lagging readily and easily available macroeconomic and financial data. So what does the US have to look forward to? As explained in my previous post, the initial reasoning for the downgrade was based on incorrect macroeconomic data assumptions, and the resulting downgrade was still pursued (read:sticking to their guns) but now only on political risk grounds. This poses and interesting question: If ratings are macroeconomic evidence-based and are sticky, then how sticky will the non-macroeconomic evidence-based US rating downgrade be? From a baseline of “nothing is seriously wrong macro-economically” how much would the situation have to improve (and how difficult/unlikely would that improvement be) to regain our triple crown?
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