Credit Rating Categories

55 Pages Posted: 6 Apr 2014

See all articles by Jin Xiang

Jin Xiang

Integrated Financial Engineering Inc.

Date Written: December 16, 2012

Abstract

In this paper I develop a model that explains why credit rating agencies classify bonds into coarse categories. The optimal number of categories and their cutoffs are outcomes of profit maximization by a rating agency. The trade-off between the number of issuers that are willing to pay for a rating and how much they are willing to pay determines these optima. The model predicts that rating standards will be tighter during non-crisis periods. It also predicts that new issuer-pay rating agencies will not use finer categories because finer categories provide less incentive for bond issuers to solicit (pay for) a rating. Consistent with the model's prediction, empirical tests show that rating standards are tighter during non-crisis periods.

Keywords: Credit rating, Categorization, Solicited and unsolicited ratings, Category cutoffs, Rating standards

JEL Classification: G20

Suggested Citation

Xiang, Jin, Credit Rating Categories (December 16, 2012). Available at SSRN: https://ssrn.com/abstract=2420672 or http://dx.doi.org/10.2139/ssrn.2420672

Jin Xiang (Contact Author)

Integrated Financial Engineering Inc. ( email )

51 Monroe Pl, Suite 1100
Rockville, MD 20850
United States
3013096560 (Phone)

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