Quo Vadis, raters? A frontier approach to identify misratings in sovereign credit risk

This study attempts to provide one of the first comprehensive analyses on the misratings in sovereign credit ratings. The analyses are performed using partial frontier methods which should be considered innovative in this literature. By combining a robust variant of the Free Disposal Hull (FDH) estimator (order-m), we measure misratings (both under- and overratings) for both individual countries and groups of countries. Particular attention is put on the comparison between pre- and crisis years, in order to assess possible changes in the magnitude of the misratings. Our findings indicate that the degree of both overratings and underratings during the analysed period (1999-2010) is indeed remarkable. These misratings partially vanish during the last years of the sample (2008-2010), corresponding to the financial crisis, when many downgrades took place, especially in Eurozone countries. The results allow us to emphasise the importance of monitoring misratings for sustainable financial stability. These results also show the potential benefits of using partial frontier methods for measuring both under- and overratings.