Abstract

http://ssrn.com/abstract=1342986
 
 

References (31)



 
 

Citations (81)



 


 



The Credit Ratings Game


Patrick Bolton


Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Xavier Freixas


Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR)

Joel Shapiro


Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

February 14, 2009

EFA 2009 Bergen Meetings Paper

Abstract:     
The spectacular failure of top-rated structured finance products has brought renewed attention to the conflicts of interest of Credit Rating Agencies (CRAs). We model both the CRA conflict of understating credit risk to attract more business, and the issuer conflict of purchasing only the most favorable ratings (issuer shopping), and examine the effectiveness of a number of proposed regulatory solutions of CRAs. We find that CRAs are more prone to inflate ratings when there is a larger fraction of naive investors in the market who take ratings at face value, or when CRA expected reputation costs are lower. To the extent that in booms the fraction of naive investors is higher, and the reputation risk for CRAs of getting caught understating credit risk is lower, our model predicts that CRAs are more likely to understate credit risk in booms than in recessions. We also show that, due to issuer shopping, competition among CRAs in a duopoly is less efficient than no competition under a monopoly CRA, in terms of both total ex-ante surplus and investor surplus. Allowing tranching decreases total surplus further. We argue that regulatory intervention requiring upfront payments for rating services (before CRAs propose a rating to the issuer) combined with mandatory disclosure of any rating produced by CRAs can substantially mitigate the conflicts of interest of both CRAs and issuers.

Number of Pages in PDF File: 46

working papers series


Download This Paper

Date posted: February 16, 2009  

Suggested Citation

Bolton, Patrick and Freixas, Xavier and Shapiro, Joel, The Credit Ratings Game (February 14, 2009). EFA 2009 Bergen Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1342986 or http://dx.doi.org/10.2139/ssrn.1342986

Contact Information

Patrick Bolton
Columbia Business School - Department of Economics ( email )
3022 Broadway
New York, NY 10027
United States
HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
HOME PAGE: http://www.ecgi.org
Xavier Freixas (Contact Author)
Universitat Pompeu Fabra ( email )
Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)
HOME PAGE: http://www.econ.upf.es/~freixas
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm
Joel David Shapiro
Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )
Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 27 18 (Phone)
+34 93 542 17 46 (Fax)
Feedback to SSRN


Paper statistics
Abstract Views: 2,275
Downloads: 718
Download Rank: 8,775
References:  31
Citations:  81

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo7 in 0.266 seconds