Credit Rating versus Credit Spread

From Open Risk Manual

Credit Rating versus Credit Spread

  • A Credit Rating is typically a more statistically driven measure of Credit Risk, used within a broader Credit Rating System and typically be defined on a limited Rating Scale
  • A Credit Spread is a market based metric that either directly (in the case of derivative instruments such as credit default swaps) or indirectly (in the case of credit sensitive bond / loan products) derives a market implied degree of credit risk

Pros and Cons

  • Market driven measures tend to respond more rapidly to new information
  • Market driven measures may have excess volatility versus the actual credit risk
  • Markets may be subject to various pathologies such as bubbles, cornered markets etc. which may diminish their risk sensitivity