best bet: bet against the S&P

Nate Silver has a great analysis of S&P national debt ratings. The post is worth a read. I won’t summarize it all here, but highlight two points. (1) “if you were an investor looking for guidance on which country’s debt was the safest to invest in, Standard & Poor’s ratings wouldn’t have done much to help you navigate the headwinds of the financial crisis.” And ever better, (2) “The evidence from the past five years suggests that it may be worthwhile to adopt a contrarian investing strategy that specifically bets against S.&P.’s ratings.” It’s also nice to see STATA output in the NYTimes.

2 Comments

  1. Posted August 9, 2011 at 11:07 am | Permalink

    I don’t really understand the point of large agencies rating sovereign debt, at least for nations like the United States, so it doesn’t surprise me that zagging when they zig might be what the smart money does.

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  2. Posted August 9, 2011 at 11:41 am | Permalink

    I think we’ve all had the experience of regressing Y~X1 and when you introduce X2 (a close correlate of X1), then X1 reverses sign and the R2 goes up slightly. Only a fool would say “bet against X1, period.” Rather, it’s only a good idea to “bet against X1″ net of X2 but if you don’t know much about X2 then X1 is still useful at face value.

    My understanding is that ratings changes often lag prices (and Silver agrees). If you’re interpreting the ratings as a regression discontinuity then on the margin it might make sense to bet against it but this is a very different thing from saying that it doesn’t convey useful information, especially to people who only know the ratings and don’t follow prices and other fundamentals directly (ie, pretty much anyone who is not a professional bond traders).

    However if you still think the ratings agencies are totally back asswards then maybe I can interest you in some ten-year Spanish bonds at just 95 cents on the dollar?

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