The Role of Credit Rating Agencies in Sovereign Bonds - Dissertation Example

Credit rating is one of the predominant features that exist. Most of the sovereign bond issues have at least one rating. The two most prominent rating agencies are Moody's and Standard & Poor's (S&P) which comply with a policy of providing a rating for most taxable sovereign bonds publicly issued in the US. Major observations in the financial markets highlighted that credit ratings have real importance. However, the financial-economic literature has doubted the importance of ratings. Specifically, there appeared to be a fundamental disagreement on the economic role of the ratings and the informational content of the ratings.

In fact, the empirical evidence surrounding credit ratings seems to be ambiguous. (El-Shagi, 2010)Credit ratings have great practical importance as they impact the cost of debt, financing structure, and even the ability to continue trading. Maintenance of financial flexibility is a very important factor followed by consideration of credit ratings in the decision to issue more debt. From the investment perspective, credit ratings are an independent source of credit analysis used at the operational level and for regulatory purposes and to limit agency costs.

For instance, restrictions on credit ratings can be considered as the mandate for the management of large public funds, restricting investment in bonds with lower credit ratings. Credit ratings are also used to manage counterparty default risk. Finally, the cost of debt financing depends on its credit rating. As credit ratings deteriorate, debt becomes more expensive. Hence, it is essential to consider carefully the impact on the credit rating at the time of making a significant financial decision.

(Loffer , 2005; Cheng and Neamtiu, 2009)2.2 Problem StatementIn most cases, academic literature in the field of credit rating has confined its focus only to firm levels or industry levels. It is not that credit rating is only vital for determining the creditworthiness of a firm or for the industry.