Rating Agencies

29 Pages Posted: 27 Mar 2015

See all articles by Harold L. Cole

Harold L. Cole

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Thomas F. Cooley

New York University - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Date Written: December 31, 2013

Abstract

For decades credit rating agencies were viewed as trusted arbiters of creditworthiness and their ratings as important tools for managing risk. The common narrative is that the value of ratings has been compromised by the evolution of the industry to a form where issuers pay for ratings. In this paper we show how credit ratings have value in equilibrium and how reputation insures that in equilibrium ratings will reflect the correct assessment of credit worthiness. There will always be an information distortion because of the fact that purchasers of ratings need not reveal them. We argue that regulatory reliance on ratings and the increasing importance of risk-weighted capital in prudential regulation have more likely contributed to distorted ratings than the matter of who pays for them. In this respect, much of the regulatory obsession with the conflict created by issuers paying for ratings is misguided.

Keywords: Ratings Agencies, Mortgaged-Backed Securities, Great Recession

JEL Classification: G2, E44

Suggested Citation

Cole, Harold L. and Cooley, Thomas F., Rating Agencies (December 31, 2013). Bank of Korea WP 2013-31. Available at SSRN: https://ssrn.com/abstract=2580596 or http://dx.doi.org/10.2139/ssrn.2580596

Harold L. Cole (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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Thomas F. Cooley

New York University - Leonard N. Stern School of Business ( email )

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