Public Sector Credit Solutions and PF2 Securities Evaluations have released a quantitative open source tool to provide an alternative or supplement to the more qualitative approach to analyzing government debt used by established ratings agencies such as Fitch, Moody’s and Standard & Poor’s.
Excerpts from the Press Release:
PF2’s Public Sector Credit Framework (PSCF) avoids several of the pitfalls facing traditional public finance methodologies used by credit rating agencies. It relies on a multi-year budget simulation that estimates annual default probabilities based on the likelihood of exceeding a user-specified fiscal threshold in any given year. These default probabilities are then converted to ratings.
“Rating agency sovereign and muni bond groups do not take advantage of the power and objectivity of quantitative techniques, leaving their methodologies vulnerable to bias and inconsistency,” said PF2 Consultant Marc Joffe, who previously researched and co-authored Kroll Bond Rating Agency’s Municipal Bond Default Study. PF2 is an independent consulting firm founded by a group of former Moody’s analysts.
The approach of using stochastic budget projections to estimate government credit risk is a natural and appealing approach to an important problem.- Ronald Lee, Director of the Center on the Economics and Demography of Aging at UC Berkeley
Programmers and analysts can review the tool’s source code and adapt it to fit their needs. PF2 has posted the software along with sample models for the US and California at http://www.publicsectorcredit.org/pscf.html and the source code on GitHub, a popular open source repository, at https://github.com/joffemd/pscf .
The California sample provided uses as a default point the ratio of interest and pension expenses to total revenue. Budget projections in this analysis rely on a range of population, economic growth, inflation, interest rate and policy scenarios. While these modeling choices may be appropriate for California, the framework accommodates a wide variety of threshold choices and budget simulation methods.
Anthony Randazzo, Director of Economic Research at The Reason Foundation, commented, “An open source tool like PSCF is a great answer to complaints about rating agency transparency. By linking a government’s projected debt burden to its risk, the framework sends the right signal both to bondholders and policymakers.”
FT Alphaville provides some additional analysis here.