Credit Rating under Ambiguity

Abstract

We consider the impact of ambiguity on credit rating with feedback effects. A firm signals its quality by surviving phases of apparent distress. A rating agency, whose analysts hold multiple priors about the firm’s true asset value, for example, due to the difficulties in the valuation of intangible assets, aims for unbiased ratings. Contrasting classical min-max results, the rating agency selects a dynamically adjusted weighted average of multiple beliefs that overweight uninformative beliefs. The ambiguity impact on ratings hinges on whether the disagreement between the analysts has a common direction: When analysts jointly perceive the firm’s value of intangibles as overstated, feedback effects make the firm delay default to benefit from the rating agency’s learning.

Keywords: Learning Dynamics, Strategic Interaction, Quantitative Debt Models, Ambiguity

JEL Classification: D83, G24, G33