Implicit ratings contributing to fundamental analysis

Rating agencies or banks are sometimes slow to react, when it comes to respond to changes relating to the creditworthiness of corporations. Implicit ratings, which exploit information from the capital markets, could be a useful contribution to the classical fundamental analysis.

Specialists of rating agencies assess the creditworthiness of a company by using a fundamental analysis. The financial and business risks of corporations together with the probability of illiquidity are expressed in a rating. As these ratings should be sustainable (at least on a mid-term basis) rumours and speculations do not serve as solid facts when assessing the company. It may be that the rating agency puts a firm on a watch list, but a change of rating is only considered when rumours turn into factual evidence.

Market prices, on the other hand, are very sensitive to existing rumours and speculation. Traders and market makers often anticipate the probability of future repercussions by making higher or lower bids. When the facts are finally evident to everyone, analysts often lag behind with their assessment much to the dissatisfaction of banks, who would then condemn the inefficiency of ratings. The concept of implicit ratings may bring an innovative solution to this dilemma. Existing market data is structured in such a way that every bond price can be converted into a implicit rating.

Investors may benefit from implicit ratings when they need to detect a possible over- or undervaluation. Analysts, on the other hand, receive some important indications for delivering reliable assessments. In the Swiss capital markets, where illiquidity is rare, the correct assessment of creditworthiness is a complicated task and is often done in consideration of various external factors. A discrepancy between implicit and fundamental rating does not always force the analyst to react, as this may often be the case due to the strong volatility of implict rating. But an ongoing discrepancy would give the analyst a signal to reconsider the current fundamental rating.

Source: Neue Z├╝rcher Zeitung


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