Ratings, Certifications and Grades: Dynamic Signaling and Market Breakdown

Stanford GSB Working Paper No. 1814 (R)

43 Pages Posted: 9 Oct 2003

See all articles by Ilan Kremer

Ilan Kremer

Independent

Andrzej Skrzypacz

Stanford University - Stanford Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 2005

Abstract

We consider the effect a public revelation of information (e.g. rating, grade) has on signaling and trading in a dynamic model. Competing buyers offer prices to a privately informed seller who can reject these offers and delay trade. This delay is costly and the seller has no commitment to the duration of the delay. We show how the external public information allows for signaling in equilibrium. More interestingly, we characterize the dynamics of trade and prices. If the signal is not fully revealing, then there is no trade just before the revelation of external information. A lemons market develops endogenously over time and prevents any trade close to the release of the public announcement. On the other hand, if the external signal is fully revealing, then trade occurs even close to the final period; however, in this case there is a discontinuity in prices.

Note: An updated version of this paper can be found at: http://ssrn.com/abstract=749265

Suggested Citation

Kremer, Ilan and Skrzypacz, Andrzej, Ratings, Certifications and Grades: Dynamic Signaling and Market Breakdown (May 2005). Stanford GSB Working Paper No. 1814 (R), Available at SSRN: https://ssrn.com/abstract=441004 or http://dx.doi.org/10.2139/ssrn.441004

Andrzej Skrzypacz

Stanford University - Stanford Graduate School of Business ( email )

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