Empirical Analysis of Credit Ratings Inflation as a Game of Incomplete Information
56 Pages Posted: 15 Jun 2014
Date Written: June 13, 2014
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: Suggested Citation