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The Systemic Risk Implications of Using Credit Ratings Versus Quantitative Measures to Limit Bond Portfolio Risk

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  • Gunter Löffler

    (Ulm University)

Abstract

Despite intense criticism, agency credit ratings are still widely used in regulation and risk management. One possible alternative is to replace them with quantitative default risk measures. For US data, I find that systemically relevant losses from corporate defaults are mostly smaller if risk-taking in portfolios is limited with the help of default probability estimates from the Credit Research Initiative rather than through Moody’s ratings. The results continue to hold when investors follow a regulatory arbitrage strategy that tilts portfolios toward issuers with high systematic risk. I further show that combining information from both measures can lead to a systemic risk profile that is more favorable than can be achieved by using only one.

Suggested Citation

  • Gunter Löffler, 2020. "The Systemic Risk Implications of Using Credit Ratings Versus Quantitative Measures to Limit Bond Portfolio Risk," Journal of Financial Services Research, Springer;Western Finance Association, vol. 58(1), pages 39-57, August.
    • Handle: RePEc:kap:jfsres:v:58:y:2020:i:1:d:10.1007_s10693-019-00321-9
    DOI: 10.1007/s10693-019-00321-9
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    More about this item

    Keywords

    Ratings; Structural models of default risk; Systemic risk; Portfolio risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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