Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll-over

Abstract:     
We propose a model of rating agencies that is an application of global game theory in which heterogeneous investors act strategically. The model allows us to explore the impact of the introduction of a rating agency on financial markets. Our model suggests that the addition of the rating agency affects the probability of default and the magnitude of the response of capital flows to changes in fundamentals in a non-trivial way, and that introducing a rating agency can bring multiple equilibria to a market that otherwise would have the unique equilibrium.

Keywords: credit rating, rating agency, sovereign debt, global game

JEL Classifications: F34, G14, G15

Working Paper Series