Rating Inflation versus Deflation: On Procyclical Credit Ratings
22 Pages Posted: 3 Nov 2013
Date Written: November 2, 2013
Credit rating agencies play a crucial role in financial markets. There are two competing views regarding their behavior: some argue that they engage in rating inflation, while others suggest that they deflate ratings. This article offers a rationale that reconciles the two opposite arguments. We find that both rating inflation and rating deflation can occur in equilibrium. Furthermore, we show that credit rating is procyclical: rating inflation is more likely to happen in a boom while rating deflation is more likely to happen in a recession.
Keywords: rating inflation, rating deflation, procyclical rating
JEL Classification: D82, G10, G24
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