Repeated Interaction and Rating Inflation: A Model of Double Reputation

American Economic Journal: Microeconomics, February 2015, 7(1): 250-80.

44 Pages Posted: 14 Dec 2012 Last revised: 22 Feb 2015

See all articles by Sivan Frenkel

Sivan Frenkel

Tel Aviv University - Coller School of Management

Date Written: February 11, 2014

Abstract

Credit-rating agencies have an incentive to maintain a public reputation for credibility among investors but also have an incentive to develop a second, private reputation for leniency among issuers. We show that in markets with few issuers, such as markets for structured assets, these incentives may lead rating agencies to inflate ratings as a strategic tool to form a “double reputation.” The model extends the existing literature on “cheap-talk” reputation to the case of two audiences. Our results can explain why rating inflation occurred specifically in markets for MBSs and CDOs during the recent financial crisis. Policy implications are discussed.

Keywords: credit-rating agencies, reputation, double reputation, two audiences

JEL Classification: G24, D82, L15, C73

Suggested Citation

Frenkel, Sivan, Repeated Interaction and Rating Inflation: A Model of Double Reputation (February 11, 2014). American Economic Journal: Microeconomics, February 2015, 7(1): 250-80.. Available at SSRN: https://ssrn.com/abstract=2188877 or http://dx.doi.org/10.2139/ssrn.2188877

Sivan Frenkel (Contact Author)

Tel Aviv University - Coller School of Management ( email )

Tel Aviv
Israel

HOME PAGE: http://https://sites.google.com/site/sivanfrenkel/

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