Default-probability-implied credit ratings for Chinese firms

Abstract

This paper estimates real-time probabilities of default (PDs) for Chinese firms and assigns PD-implied ratings benchmarked to the historical default rates of S&P rating categories. PD-implied ratings tend to be lower and more granular than those issued by domestic credit rating agencies (DCRAs). They outperform DCRA ratings in predicting defaults and offer complementary information in credit price discovery. In terms of information content, PD-implied ratings incorporate richer and more persistent cashflow information than DCRA ratings do. Contributing factors such as implicit government guarantees and the moral hazard inherent in the issuer-pays business model play a significant role in elevating DCRA ratings, leading to greater divergence from PD-implied ratings and, consequently, differences in default prediction performance.