Recommend a book for theory behind bond ratings

[Dari]

I want to understand the basics. The underlying parameters. Not sure if what I'm asking for is company secret but whatever.

Been out of school too long. I would like a book or seminal paper on the math behind ratings (if it even exists). None of the traders know it and I'm trying to reserve the capital I have with my former professors for something more substantial. Thanks.

 

[thumper01]

I don't know of any books, not that there aren't any, I just don't know of any. However, for Moody's and S&P you can find information regarding their ratings criteria and methodology on their websites. S&P requires you to sign up for free access to get to the information. I haven't looked at Moody's in a long time, so I don't know what is free and what isn't. The other NRSRO's (Fitch, DBRS, Egan-Jones, etc) may also provide their methodologies as well.

 

[mshan]

Bond Rating Agencies get paid by companies that want to issue bonds with great ratings so things like pension funds are allowed to buy them.

Plus argument that if I (i. e. one of the big bond rating agencies) don't give them the seal of approval bond issuer wants, they'll just go to my competitor to get it and I'll lose business and market share.

Hmmm, can't see how that business model could possibly lead to conflicts of interest, eh?

From what I've seen on tv, Egan-Jones does not get paid in same way and is trying to compete with others to get foothold in market, so perhaps dig around their website and see what criticisms they have of how other bond raters work. Then do further due diligence (e. g. http://www.google.com/search?hl=en&....0.0.4.363.1565.0j2j2j2.6.0...0.0.PbtHx2KSW7o) make sure what Egan-Jones is saying is true and not just self-serving in some other way.

"Sean Egan, principal of Egan-Jones Rating, appeared before Congress on October 22, 2008 and argued that issuers of complex securities "shopped" for ratings which resulted in a race to the bottom in terms of credit transparency. Rather than "beat up Moody's and S&P for behavior" they'd been financially motivated to pursue, the government needs to support a new business model paid for by investors, not issuers, to support the funding ecosystem which has so severely broken down, he asserted."

http://en.wikipedia.org/wiki/Egan-Jones_Ratings_Company

 

[yllus]

Interesting question! There's a few books that explain the stock side of the market, but I've never heard of anything that gives a basis on how to rate bonds. Looking forward to the responses.

 

[Dari]

I don't know of any books, not that there aren't any, I just don't know of any. However, for Moody's and S&P you can find information regarding their ratings criteria and methodology on their websites. S&P requires you to sign up for free access to get to the information. I haven't looked at Moody's in a long time, so I don't know what is free and what isn't. The other NRSRO's (Fitch, DBRS, Egan-Jones, etc) may also provide their methodologies as well.

Thanks, I'll look into it. I hope it isn't fluff but real algorithms...

 

[Dari]

Interesting question! There's a few books that explain the stock side of the market, but I've never heard of anything that gives a basis on how to rate bonds. Looking forward to the responses.

Do you have a link to that? I cannot imagine it being too different.

 

[the DRIZZLE]

Can you be more specific about what you are trying to do? There are two ways to look at credit analysis. One way is to directly predict the default risk by looking at certain metrics using something like the Altman Z score. The other way is to predict the credit rating that a company would receive from the rating agencies.

If the credit rating agencies are doing a good job the two methods should result in the same answer but people like Edward Altman will tell you their methods are better for predicting actual default risk. However, depending on what you are doing the credit rating may be all you need.

edit: This is the only book I've read on the subject. http://www.amazon.com/Corporate-Fin...uptcy-Distressed/dp/0471691895/ref=pd_sim_b_2

 

[Dari]

Can you be more specific about what you are trying to do? There are two ways to look at credit analysis. One way is to directly predict the default risk by looking at certain metrics using something like the Altman Z score. The other way is to predict the credit rating that a company would receive from the rating agencies.

If the credit rating agencies are doing a good job the two methods should result in the same answer but people like Edward Altman will tell you their methods are better for predicting actual default risk. However, depending on what you are doing the credit rating may be all you need.

I guess I'm really asking whether or not the methodologies are subjective or based on an algorithm. If it's the latter then there should be a general theory behind the ratings. I want to read up on that. If not, then I guess I can look at the qualifications that determines a good rating.

EDIT: Also, thanks for mentioning Altman Z score. That has given me something (algorithm-based) to look into.

 

[yllus]

Do you have a link to that? I cannot imagine it being too different.

True enough. What I'd go to on the stock side is a combination of The Intelligent Investor by Ben Graham and Common Stocks and Uncommon Profits by Philip A. Fisher (maybe the Fisher book more than the Graham one).

 

[the DRIZZLE]

I guess I'm really asking whether or not the methodologies are subjective or based on an algorithm. If it's the latter then there should be a general theory behind the ratings. I want to read up on that. If not, then I guess I can look at the qualifications that determines a good rating.

EDIT: Also, thanks for mentioning Altman Z score. That has given me something (algorithm-based) to look into.

They are all algorithm based but they are proprietary since that's really the entire value add of the rating agencies. You can think of the Altman Z score as the standard "open source" model. I'll add that in practice credit analysis is done much differently than equity analysis, especially for investment grade companies. When you get to junk bonds or distressed companies the two have more in common because the debt starts to look more like equity.

 

[Dari]

They are all algorithm based but they are proprietary since that's really the entire value add of the rating agencies. You can think of the Altman Z score as the standard "open source" model. I'll add that in practice credit analysis is done much differently than equity analysis, especially for investment grade companies. When you get to junk bonds or distressed companies the two have more in common because the debt starts to look more like equity.

Thanks. Then that's where I'll start.

 

[Dari]

True enough. What I'd go to on the stock side is a combination of The Intelligent Investor by Ben Graham and Common Stocks and Uncommon Profits by Philip A. Fisher (maybe the Fisher book more than the Graham one).

Thanks. I have the first book but never got around to reading it. Never heard of the second.

 

[Soundmanred]

Unlike most people, I prefer the Connery years.

 

[Dari]

Unlike most people, I prefer the Connery years.

Who is that and what work did he produce? Can you link a book/paper?

 

[Soundmanred]

Who is that and what work did he produce? Can you link a book/paper?

Wow, where do I begin?
He started off in Dr. No, then moved on to Goldfinger, Thunderball, You Only Live Twice, etc.
Ian Fleming was a literary genius in the genre.

 

[yllus]

Wow, where do I begin?
He started off in Dr. No, then moved on to Goldfinger, Thunderball, You Only Live Twice, etc.
Ian Fleming was a literary genius in the genre.

I knew someone was going to make this joke. Craig > Moore > Connery.