Bond ratings are usually first assigned by rating agencies to public debt at the time of issuance and are periodically reviewed by the rating companies. If deemed warranted, changes in ratings are assigned after the review. A change in a rating reflects the agency’s assessment that the company’s credit quality has improved (upgrade) or deteriorated (downgrade). A coincident effect, in some proximity to the date of the rating change, is a change in the price of the issue. This article reports on an in-depth investigation of the expected ratings changes (drift) over time. Our analysis compares rating changes from the two major agencies, Moody’s and S&P, over the period 1970–1996. For the first time, results from several studies which have documented and analyzed these data patterns are contrasted. Depending upon which study one uses, the results and implications can be very different. We expect that the findings will have implications for such diverse practitioners as bond investors who concentrate on any or all segments of the corporate bond market, eg., high yield bond and “crossover” investors, mark-to-market analysts, and traders in the new and growing market for credit-risk-derivatives and for the many analysts who properly view that credit quality assessment involves the entire spectrum of possible outcomes, not just default. A follow-up study will analyze, in greater depth, two critical characteristics of the rating drift phenomenon. These are unexpected, as well as expected, rating migration patterns and also the implied impact on the price of the fixed income instrument.

In a recent article in this Journal Joy and Tollefson [10] (hereafter J&T) critically analyzed discriminant analysis and its application to bankruptcy analysis. The authors make several interesting points and provide a useful discussion of the application of this statistical technique in finance. There are, however, three aspects of their presentation which need further elaboration. These relate to their discussions of (1) the difference between the stability of the discriminant model and its predictive ability, (2) the alternative methods of making inferences about the relative discriminatory power of variables, and (3) the reference statistics to use in assessing classification efficiency. In commenting on these points we will make use of the data from the Altman [1] study as did J&T.

This study is another attempt to analyze the behavior of common stock prices. In the last decade, and even before that, literature has spewed forth an abundant supply of studies in this area, from random walkers, to optimum portfolioers, to performance measurers. Terms such as risk and return, variance and covariance, and variability and volatility proliferate journal pages and our daily conversations.

This paper examines two specific aspects of stage 1 of the Bank for International Settlement’s (BIS’s) proposed reforms to the 8% risk-based capital ratio. We argue that relying on “traditional” agency ratings could produce cyclically lagging rather leading capital requirements, resulting in an enhanced rather than reduced degree of instability in the banking and financial system. Despite this possible shortcoming, we believe that sensible risk based weighting of capital requirements is a step in the right direction. The current risk based bucketing proposal, which is tied to external agency ratings, or possibly to internal bank ratings, however, lacks a sufficient degree of granularity. In particular, lumping A and BBB (investment grade corporate borrowers) together with BB and B (below investment grade borrowers) severely misprices risk within that bucket and calls, at a minimum, for that bucket to be split into two. We examine the default loss experience on corporate bonds for the period 1981–1999 and propose a revised weighting system which more closely resembles the actual loss experience on credit assets.

This paper traces developments in the credit risk measurement literature over the last 20 years. The paper is essentially divided into two parts. In the first part the evolution of the literature on the credit-risk measurement of individual loans and portfolios of loans is traced by way of reference to articles appearing in relevant issues of the Journal of Banking and Finance and other publications. In the second part, a new approach built around a mortality risk framework to measuring the risk and returns on loans and bonds is presented. This model is shown to offer some promise in analyzing the risk-return structures of portfolios of credit-risk exposed debt instruments.

The author was extremely interested to find that Professor Rick Elam had conducted a study analyzing the effect of lease data on the predictability of financial ratios, for bankruptcy prediction. Prediction could be improved by adding to the asset and liability base and the probable effect on earnings when leases are capitalized. Problem firms utilize leasing to a greater extent than non-problem firms, although this relatively greater use may change as the bankruptcy date approaches. Professor Deakin found that failed firms tended to expand quite rapidly several years prior to failure and that the "expansion was financed by increased debt and preferred stock rather than common stock and retained earnings." Elam clearly has made a contribution in his assessment of lease capitalization on ratio predictability. The analysis did not go far enough in its investigation of relative lease usage, the comprehensiveness of ratio inclusion and the sophistication of the statistical technique utilized. Since lease capitalization is now accepted by academicians and practitioners alike, a full understanding of its impact is crucial.

Reviews the book "Taxable Income," by Roswell Magill.