Optimal Ratings

66 Pages Posted: 24 Apr 2017 Last revised: 6 Feb 2019

See all articles by Jordan Martel

Jordan Martel

Indiana University Bloomington - Kelley School of Business

Edward Dickersin Van Wesep

University of Colorado at Boulder - Department of Finance

Robert Van Wesep

Independent

Date Written: January 28, 2019

Abstract

Ratings are often coarse. Examples include corporate debt ratings, stock analyst recommendations, Morningstar ratings, bank analyst evaluations, referee suggestions to editors, student grades, Yelp ratings, and film reviews. In the classic Crawford-Sobel (1982) model, coarse messaging is not optimal if the sender's and receiver's interests coincide. In the situations listed above, senders' and receivers' interests likely do coincide and the rating systems appear to be deliberately chosen. We provide a cheap talk model in which messages are received with exogenous noise and show that the optimal rating system may be coarse: while coarse messages are less precise, they are easier to interpret. In numerical work, we derive predictions for the distribution of ratings and show that the distributions we see in practice match the predictions of the model.

Keywords: Cheap Talk, Discrete, Coarse, Yelp, Credit Ratings, Stock Analysts

JEL Classification: D83, G00, M00

Suggested Citation

Martel, Jordan and Van Wesep, Edward Dickersin and Van Wesep, Robert, Optimal Ratings (January 28, 2019). Available at SSRN: https://ssrn.com/abstract=2950813 or http://dx.doi.org/10.2139/ssrn.2950813

Jordan Martel

Indiana University Bloomington - Kelley School of Business ( email )

1309 E 10th Street, Hodge Hall 4100
Bloomington, IN 47405
United States

Edward Dickersin Van Wesep (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States

Robert Van Wesep

Independent ( email )

No Address Available

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