Are Credit Ratings Relevant in China’s Corporate Bond Market?

Abstract

While China may imitate the United States in establishing and regulating its nascent credit rating industry, the reputation and influence of the rating agencies may take years to develop. This observation has led to suggestions that investors have largely discounted the opinions of Chinese credit rating agencies. Using post-2005 data, we find that credit spreads and bond ratings in China display a similar relation to that found in the United States. In particular, this relation remains significant after controlling for bond-level and firm-level characteristics. This suggests that investors indeed use credit ratings to determine the risk premiums on Chinese corporate bonds.

Keywords:

• corporate bonds
• credit ratings
• China
• risk premiums

Notes

They are A.M. Best, DBRS, Egan-Jones, Fitch, HR Ratings de Mexico, Japan Credit Rating, Kroll, Moody’s, Morningstar, and S&P’s. See http://www.sec.gov/about/offices/ocr.shtml for details.

As of 2013, the four major Chinese domestic rating agencies were China Chenxin International Credit Rating, Dagong Global Credit Rating, Lianhe Credit Rating, and Shanghai Brilliance Credit Rating.

While this casual comparison might suggest that Chinese bonds with nominally higher ratings (say AA) have the same default risk as U.S. bonds with nominally lower ratings (say BBB), we note that the yield spread reflects both the level of default risk and investors’ risk premium toward default, as well as other factors such as liquidity and tax effects (Elton et al. 2001).

It is common in the literature to measure the risk premium of corporate bonds using the yield spread, e.g., Fisher (1959), Campbell (1980), Kidwell et al. (1985), and Fung and Rudd (1986).

See, for example, Altman (1968), Pogue and Soldofsky (1969), Horrigan (1966), and Ederington (1986).

See, for example, Hickman (1958), West (1973), Liu and Thakor (1984), Ederington (1986), and Kao and Wu (1990).

A colorful account of how the tension between the various regulators has come to shape the Chinese corporate bond market can be found in Kennedy (2008).

In 2013, around $1.3 trillion of corporate bonds were issued in the U.S. (http://www.sifma.org/research/statistics.aspx), and the average daily issuance of commercial paper in the U.S. was about $78 billion, for a total of $2.8 trillion issued for the year (http://www.federalreserve.gov/releases/cp/volumestats.htm).

See, for example, Bierman and Haas (1975) and Lamy and Thompson (1988).

Other model selection techniques can also be used, e.g., the Akaike Information Criterion (AIC).

This is true in studies that use U.S. data as well (e.g., Elton et al. 2001).

These market statistics come from WIND. China’s corporate bonds include commercial paper, medium-term notes, long-term corporate bonds, and bonds issued by various financial institutions excluding the major policy banks.