Rating Under Asymmetric Information

88 Pages Posted: 16 Jun 2017 Last revised: 18 Apr 2018

See all articles by Christian Hilpert

Christian Hilpert

Sun Yat-Sen University (SYSU) - Lingnan (University) College

Stefan Hirth

University of Southern Denmark (SDU)

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration

Date Written: June 15, 2017

Abstract

We study a dynamic signaling game where a firm, by its decision to stay solvent, signals its quality to a rating agency with the rating feeding back into the firm’s cost of capital. Observing the firm’s true cash flow blurred by a persistent measurement error, the error-minimizing rating agency learns dynamically through the firm’s solvency decision. Firms observed with higher measurement error default earlier, inducing directional learning by successively eliminating measurement errors which are too high to be feasible. In a partially separating perfect Bayesian equilibrium in Markov strategies, the firm employs a measurement-error dependent cut-off strategy. We discuss the extensive economic consequences of such a learning mechanism.

Keywords: Rating, Performance Sensitive Debt, Asymmetric Information, Learning, Markov Perfect Bayesian Equilibrium

JEL Classification: G12, G14, G32

Suggested Citation

Hilpert, Christian and Hirth, Stefan and Szimayer, Alexander, Rating Under Asymmetric Information (June 15, 2017). Available at SSRN: https://ssrn.com/abstract=2986850 or http://dx.doi.org/10.2139/ssrn.2986850

Christian Hilpert (Contact Author)

Sun Yat-Sen University (SYSU) - Lingnan (University) College ( email )

Guangzhou
China

Stefan Hirth

University of Southern Denmark (SDU) ( email )

DK-5230 Odense
Denmark

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

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