Arm’s Length Method for Comparing Rating Scales

Investors are being encouraged after the global crisis to reduce their dependence on the largest credit rating agencies for risk assessments of companies and securities. Comparing risk assessments from different sources rapidly becomes non-trivial when more than three credit rating agencies are involved. We propose a method for comparing rating scales, and hence constructing correspondence diagrams and tables, thereby treating the rating scales used by different agencies as objects of study. Scales are compared by looking at sets of ratings assigned to similar entities (hereinafter banks) with the assumption that the risk being measured by each credit rating agency is the same for a given rated entity at a given point in time. Studying international bank ratings for a five-year period shows that there are subtle differences for the largest credit rating agencies. A mechanism for constructing mappings between scales could lead to more competition with new credit rating agencies. Copyright Eurasia Business and Economics Society 2013