An industrial bond rating model based on the analytic hierarchy process

Bond ratings serve as perceived indicators of the default risk associated with bond issues and issuers. A review of the descriptions of the ratings process followed by the agencies reveals that an informal judgmental system is used to rate bond issues. However, informal judgmental systems have the potential to induce serious inconsistencies in decisions. Such inconsistencies can occur with respect to the relative importance of criteria applicable to the same issues over time and also across issuers. The authors present a formal judgmental model of the bond ratings process that does not suffer from the weaknesses of informal judgmental systems. The model relies on the descriptions of the process published by Standard and Poor’s Corporation and is based on the Analytic Hierarchy Process. Model use is illustrated by analyzing the bond ratings of Chrysler Corporation and General Motors. The model should prove useful to ratings agencies, bond issuers and institutional investors. Ratings agencies can adopt a more systematic and consistent approach towards rating bond issues. Issuers and institutional investors can examine the perceived consistency and appropriateness of the rating assigned to a firm’s debt by providing inferences concerning the rating criteria.