Natural Barrier to Entry in the Credit Rating Industry

31 Pages Posted: 16 Mar 2010

See all articles by Doh-Shin Jeon

Doh-Shin Jeon

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Stefano Lovo

HEC Paris - Finance Department

Date Written: February 8, 2010

Abstract

This paper examines whether there is a natural barrier to entry in the credit rating industry. We consider an in…nite horizon model in which each period, an original incumbent faces competition from an entrant randomly selected from a pool of ex ante identical potential entrants. The incumbent's accuracy is imperfect, constant and known while each entrant's true accuracy is unknown and can be perfect or completely noisy. In the benchmark in which the signal that a CRA receives is public information, we …nd that the market provides either a right or a socially excessive incentive to experiment with entrants. On the contrary, when the signal is private information, the experimentation never occurs. Our result suggests that a rather incompetent CRA can dominate the market without being worried about entry of potentially more competent entrants and can explain the current failure of the credit rating industry. We derive policy implications

Keywords: Credit Rating, Entry Barrier, Market Structure, Reputation, Private Information

JEL Classification: D82, G29, L11, L13, L15

Suggested Citation

Jeon, Doh-Shin and Lovo, Stefano, Natural Barrier to Entry in the Credit Rating Industry (February 8, 2010). Available at SSRN: https://ssrn.com/abstract=1571649 or http://dx.doi.org/10.2139/ssrn.1571649

Doh-Shin Jeon

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(34) 93 542 16 57 (Phone)
(34) 93 542 17 46 (Fax)

Stefano Lovo (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

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