Bond rating determinants and modeling: evidence from India

Abstract

Purpose

This study attempts to identify fundamental determinants of bond ratings for non-financial and financial firms. Further the study aims to develop a parsimonious bond rating model and compare its efficacy across statistical and range of machine learning methods in the Indian context. The study is motivated by the insufficiency of prior work in the Indian context.

Design/methodology/approach

The authors identify the critical determinants of non-financial and financial firms using multinomial logistic regression. Various machine learning and statistical methods are employed to identify the optimal bond rating prediction model. The data cover 8,346 bond issues from 2009 to 2019.

Findings

The authors find that industry concentration, sales, operating leverage, operating efficiency, profitability, solvency, strategic ownership, age, firm size and firm value play an important role in rating non-financial firms. Operating efficiency, profitability, strategic ownership and size are also relevant for financial firms besides additional determinants related to the capital adequacy, asset quality, management efficiency, earnings quality and liquidity (CAMEL) approach. The authors find that random forest outperforms logit and other machine learning methods with an accuracy rate of 92 and 91% for non-financial and financial firms.

Practical implications

The study identifies important determinants of bond ratings for both non-financial and financial firms. The study interalia finds that the random forest technique is the most appropriate method for bond ratings predictions in India.

Social implications

Better bond ratings may mitigate corporate defaults.

Originality/value

Unlike prior literature, the study identifies determinants of bond ratings for both non-financial and financial firms. The study also experiments with modern machine learning techniques besides the traditional statistical approach for model building in case of relatively under researched market.

Citation

Sehgal, S., Vasishth, V. and Agrawal, T.J. (2023), "Bond rating determinants and modeling: evidence from India", Managerial Finance, Vol. 49 No. 3, pp. 529-554. https://doi.org/10.1108/MF-10-2021-0489