Avoiding the rating bounce

Rating agencies state that they take a rating action only when it is unlikely to bereversed shortly afterwards. Based on a formal representation of the rating process, Ishow that such a policy provides a good explanation for the empirical evidence: Ratingchanges occur relatively seldom, exhibit serial dependence, and lag changes in theissuers’ default risk. In terms of informational losses, avoiding rating reversals can bemore harmful than monitoring credit quality only twice per year.