Modeling Sovereign Credit Score of US and UK

Sovereign Credit Ratings play a significant role in attracting foreign investments. Credit Rating Agencies (CRAs) specialize in assessing the creditworthiness of sovereign issuers. Moodys Investors Service (Moodys), Standard and Poors (S&P), and Fitch Ratings (Fitch) are the dominant CRAs. A rating upgrade is a positive change in a sovereigns rating triggered by steady improvements in the political and economic environment whereas a downgrade for a country means a negative change, indicating a worsening economic and business environment. Investors see a downgrade as a risky bet and demand higher returns to lend to these governments.

CRAs are corporations specializing in assessing the credit risk of potential debtors by predicting their ability to pay back financial obligations and forecasting the probability of default. CRAs analyse various parameters or risks (economic and political) that affect the ability of debtors to pay their debts. These agencies reduce information asymmetry between investors and issuers regarding the creditworthiness of a corporation or a country.

Credit Rating Agencies (CRAs) play a crucial role in reducing the asymmetry in the information available to the issuer and the investor. This role gains even more significance when rating is for sovereign entities and their securities. The CRAs like S&P, Moodys, and Fitch, which rate sovereign entities, consider several variables both qualitative and quantitative to assess the creditworthiness and rating of these entities and their securities. The case study gives a view of the sovereign credit rating industry, its major players, the industry issues and controversies.

The case also discusses the variables and parameters used by these big 3 agencies to rate sovereign entities. Most importantly, the case study helps the students to develop a basic model taking generally accepted variables to arrive at a credit score for two of the largest economies in the world the US and the UK. This will help the student appreciate the various variables that go into sovereign credit rating apart from helping them to develop a basic model and analyse the creditworthiness of the two sovereign entities. The case also comes with Excel supplements.

Questions: (30 Marks)

1. Develop a revised model to arrive at rating scores for the US and UK after COVID-19

2. Explain the Variables/parameters used by major sovereign rating agencies like Fitch, S&P, Moodys

3. Debate and discuss the scope for adding more variables or changing the weights of a variable and appreciate the scope for interpretation bias, given the need to incorporate qualitative parameters.