Empirical Analysis of Credit Ratings Inflation as a Game of Incomplete Information

56 Pages Posted: 15 Jun 2014

Date Written: June 13, 2014

Abstract

This paper models competition among credit rating agencies as an auction. Equilibrium ratings give a distorted representation of agencies' true assessment of quality, because the agencies choose their ratings strategically. I quantify the distortion in ratings for individual commercial mortgage-backed securities, and find the extent of distortion to be an important predictor of the securities' ex post performance. I also find that the distortion magnitudes decreased after the recent financial crisis. Through counterfactual simulations, I determine the marginal impact of additional rating agencies on distortions, and I identify the impact of proposed disclosure requirements.

Keywords: games of incomplete information, auctions, rating agencies, information intermediaries, securitization

JEL Classification: L1, G24

Suggested Citation

Chu, Chenghuan Sean, Empirical Analysis of Credit Ratings Inflation as a Game of Incomplete Information (June 13, 2014). Available at SSRN: https://ssrn.com/abstract=2450187 or http://dx.doi.org/10.2139/ssrn.2450187

Chenghuan Sean Chu (Contact Author)

Federal Reserve Board of Governors ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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