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The Effects of Rating through the Cycle on Rating Stability, Rating Timeliness and Default Prediction Performance

by Edward I. Altman of the New York University, and
Herbert A. Rijken of Vrije Universiteit Amsterdam

March 2005

Abstract: The role and performance of credit rating agencies are currently under debate. Several surveys conducted in the United States reveal that most investors believe that rating agencies are too slow in adjusting their ratings to changes in corporate creditworthiness. Well known is that agencies achieve rating stability by their through-the-cycle methodology. This study aims to provide quantitative insight in this methodology and to quantify the effects of this methodology on rating stability, rating timeliness and default prediction performance, from an investor's point-in-time perspective. We believe that our results can guide the search for an optimal balance between rating stability, rating timeliness and default prediction performance.

JEL Classification: G20, G33.

Keywords: Rating agencies, through-the-cycle rating methodology, migration policy, credit scoring models, default prediction.

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