An Equilibrium Model of Credit Rating Agencies
34 Pages Posted: 20 Mar 2013
Date Written: December 18, 2012
We develop a model of credit rating agencies (CRAs) based on reputation concerns. Ratings affect investors' choice and, thereby, also issuers' access to funding and default risk. We show that - in equilibrium - the informational content of credit ratings is inferior to that of CRAs' private information. We find that CRAs have a pro-cyclical impact on default risk: in a liquidity boom CRAs help resolve investors' coordination problem, and lower the probability of default; in a liquidity crunch CRAs raise the probability of default. Furthermore, rating standards tend to be pro-cyclical, while biased CRA-incentives will ultimately be selfdefeating.
Keywords: Credit rating agencies, global games, coordination failure
JEL Classification: G24, G33, D82, C72
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