S&P sovereign debt ratings are worse than worthless: they are less informative than the simple debt-to-GDP ratio alone

Former McKinsey consultant and current Yale Law student James Kwak summarizes Standard and Poor’s performance in predicting government defaults, and the results do not look good for the fellows in the clown car. From The Baseline Scenario:

. . . In the conventional model, rating agencies are information providers: they produce information that is useful to market participants, and thereby improve the functioning of the markets. Well, forget all that. Nate Silver has the best article I’ve seen yet on S&P’s sovereign debt ratings, and the summary is that it isn’t pretty. Some of the things Silver finds, using some publicly available data and Stata, are:

  •  Debt-to-GDP ratio alone is a better predictor of default risk than an S&P rating (meaning that the rating subtracts information provided by the debt-to-GDP ratio).
  • S&P ratings have almost no correlation with future default risk.
  • S&P rates European countries higher than other countries, all other things being equal—and look where that got us.
  • S&P ratings are serially correlated, which means they incorporate new information especially slowly.

About Guy N. Texas

Guy N. Texas is the pen name of a lawyer living in Dallas, who is now a liberal. He was once conservative, but this word has so morphed in meaning that he can no longer call himself that in good conscience. Guy has no political aspirations. He speaks only for himself.
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