Grant McDermott bio photo

Grant McDermott

Assistant Professor
Dept. of Economics
University of Oregon

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Interesting new paper on "The Home Bias In Sovereign Ratings":
Fuchs and Gehring find clear evidence of “home bias” [among credit ratings agencies]. Specifically, their analysis finds that agencies do indeed assign higher ratings to their home country governments compared to other countries with the same characteristics. This result was especially strong during the global financial crisis (GFC) years–nearly a 2 point “bump” in ratings.
As someone who has been both a consumer and producer of sovereign rating reports prior to starting a PhD, I find this sort of thing very interesting. The role of inherent biases in the industry is scope for bemusement and alarm. The Fuchs and Gehring paper would at least seem to go some of the way in explaining why, say, Fitch places the United States in its highest credit ratings category... while (Chinese-based agency) Dagong only places the US in its third highest category.

That being said, Daniel McDowell (author of the above blog post) points out that it is not especially clear how such findings actually stand to affect future ratings. For one thing, changes in sovereign ratings sometimes have zero, or even paradoxical effects, such as when the demand for US treasuries actually rose following the country's downgrade by Standard & Poors in 2011.[*]

On the other hand, it should also be noted that if one of the other major agencies \(-\) i.e. Fitch or Moody's \(-\) had followed S&P's lead in downgrading the US credit score in 2011, then that probably would have had fairly major financial implications. Most obviously, a large number of investment funds have specific mandates regarding the type of securities they must hold... as determined by the average score among the big three credit ratings agencies. For example, a fund might be legally required to hold a minimum proportion of "triple-A-rated" bonds. Given how ubiquitous US treasuries are, some major portfolio rebalancing would almost certainly be required if the US lost its "average" credit rating. You may recall that this is something that a lot of people were worried about at the time. It is also one reason that the ratings agencies continue to have a practical (and potentially deleterious) relevance to financial markets.

Anyway, apologies for getting sidetracked. Interesting paper and blog post. Check them out.
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[*] A popular explanation at the time was that the downgrade provided the shake-up that Congress needed in order to overcome the political impasse over the debt ceiling...