Credit Rating Dynamics and Competition

Abstract:     
I analyze credit rating agencies and competition on a market with more than two agencies. Both investors and agencies react to each other’s behavior. My model predicts cyclic dynamics in the base case: not only does the presence of trusting investors facilitate ratings inflation. In turn, ratings inflation also induces investors to be less trusting. If trusting investors have a high impact on agencies’ reputation, the dynamics exhibits a saddle point rather than cycles. This is one case in which regulatory support for new, honest rating agencies is only needed for a limited time, but the effect is sustainable in the long run.

Number of Pages in PDF File: 39

Keywords: credit rating agencies, ratings inflation, evolutionary game theory

JEL Classification: D43, D82, G24, L15

working papers series