Journal of Credit Risk

Adjusting corporate default rates for rating withdrawals

Richard Cantor, David T. Hamilton


Many market practitioners base their parameter estimates on results reported in rating-agency default studies. Although the comparability of default rates reported by the agencies has increased in recent years, many differences in default rate calculation methodologies remain. One important and poorly understood methodological difference is whether default rate estimates are (or should be) statistically adjusted for issuer-rating withdrawals, which occur when borrowers shift from rated public to unrated private debt finance, or when all their debts are extinguished outright. In this article, we review the mechanics and rationale behind the unadjusted and withdrawal-adjusted default rate calculation methodologies. We discuss the relative merits of adjusting or not adjusting for rating withdrawals and the importance of the assumptions underlying each method. We demonstrate that the assumption of random data censoring posited by the withdrawaladjusted method is supported by the available data. We conclude that withdrawal- adjusted default rates are the appropriate estimates of expected default rates for obligations with specific expected tenors and provide common yardsticks for comparing default risk for credit exposures across different sectors, regardless of differences in realized rating withdrawal rates.

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