Credit Rating and Competition

44 Pages Posted: 21 Mar 2010 Last revised: 2 Aug 2012

Nelson Camanho

Catholic University of Portugal (UCP) Catolica Lisbon School of Business and Economics; London School of Economics & Political Science (LSE) - Financial Markets Group

Pragyan Deb

International Monetary Fund (IMF); London School of Economics & Political Science (LSE) - Financial Markets Group

Zijun Liu

Bank of England

Date Written: July 2012

Abstract

We develop a theoretical model to analyse the e ect of competition on the conflict of interest arising from the issuer pay compensation model of the credit rating industry. We nd that relative to monopoly, rating agencies are more likely to inflate ratings under competition, resulting in lower expected welfare. These results do not depend on the presence of ratings shopping as in Bolton, Freixas, and Shapiro (2012) and Skreta and Veldkamp (2009), but instead focus on the trade-o ff between maintaining reputation (to increase profi ts in the future) and in ating ratings today (to increase current pro fits). Our results suggest that ongoing regulatory initiatives aimed at increasing competition in the ratings industry may reduce overall welfare, unless new entrants have a higher reputation via-a-vis incumbents.

Keywords: Rating agencies, competition, reputation, repeated games, financial regulation

JEL Classification: C73, D43, D82, D83, G24

Suggested Citation

Camanho, Nelson and Deb, Pragyan and Liu, Zijun, Credit Rating and Competition (July 2012). 22nd Australasian Finance and Banking Conference 2009; AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1573035 or http://dx.doi.org/10.2139/ssrn.1573035

Nelson Camanho

Catholic University of Portugal (UCP) Catolica Lisbon School of Business and Economics ( email )

UCP 501082522
Palma de Cima
Lisbon, 1649-023
Portugal

HOME PAGE: http://sites.google.com/site/ncamanho/

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Pragyan Deb (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Zijun Liu

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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