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A Nonparametric Test for Credit Rating Refinements

by Ross M. Miller of Miller Risk Advisors

May 1998

First Paragraph: While the intensive quantification of market risk has led to measurements accurate to the basis point (and beyond), difficulties in quantifying credit risk have resulted in the practice of measuring this risk with far less precision.  Indeed, financial institutions that develop their own internal measures of credit risk usually employ a "1" to "9" scale of creditworthiness for their exposures, taking their lead from the rating agencies and their AAA to D (and similar) systems.  Even with the further refinement of "notches," designated with a "+" or "-" the vast universe of credit risk is reduced to at most thirty buckets. In reality, the broad range of pricing for corporate debt obligations in the marketplace indicates that there are far more than thirty categories of credit risk.  In the high-yield debt market the illusion of "stability" provided by a broad categorization scheme can be easily outweighed by its imprecision.

Published in: "Refining Risk", RISK, Vol. 11, No. 8, (August 1998), pp. ??-??.

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