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Rating agencies in the face of regulation

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Author Info

  • Opp, Christian C.
  • Opp, Marcus M.
  • Harris, Milton

Abstract

This paper develops a theoretical framework to shed light on variation in credit rating standards over time and across asset classes. Ratings issued by credit rating agencies serve a dual role: they provide information to investors and are used to regulate institutional investors. We show that introducing rating-contingent regulation that favors highly rated securities may increase or decrease rating informativeness, but unambiguously increases the volume of highly rated securities. If the regulatory advantage of highly rated securities is sufficiently large, delegated information acquisition is unsustainable, since the rating agency prefers to facilitate regulatory arbitrage by inflating ratings. Our model relates rating informativeness to the quality distribution of issuers, the complexity of assets, and issuers' outside options. We reconcile our results with the existing empirical literature and highlight new, testable implications, such as repercussions of the Dodd-Frank Act.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 108 (2013)
Issue (Month): 1 ()
Pages: 46-61

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Handle: RePEc:eee:jfinec:v:108:y:2013:i:1:p:46-61

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Web page: http://www.elsevier.com/locate/inca/505576

Related research

Keywords: Financial regulation; Rating agencies; Certification; Dodd-Frank Act;

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References

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  1. Adam Ashcraft & Paul Goldsmith-Pinkham & Peter Hull & James Vickery, 2011. "Credit Ratings and Security Prices in the Subprime MBS Market," American Economic Review, American Economic Association, vol. 101(3), pages 115-19, May.
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Citations

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Cited by:
  1. Ashcraft, A. & Goldsmith-Pinkham, P. & Vickery, J., 2010. "MBS Ratings and the Mortgage Credit Boom," Discussion Paper 2010-89S, Tilburg University, Center for Economic Research.
  2. Sergei Kovbasyuk, 2013. "Seller - paid Ratings," EIEF Working Papers Series 1330, Einaudi Institute for Economics and Finance (EIEF), revised Nov 2013.
  3. Wojtowicz, Marcin, 2014. "CDOs and the financial crisis: Credit ratings and fair premia," Journal of Banking & Finance, Elsevier, vol. 39(C), pages 1-13.
  4. Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.
  5. Lawrence J. White, 2013. "Credit Rating Agencies: An Overview," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 93-122, November.
  6. Xia, Han, 2014. "Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?," Journal of Financial Economics, Elsevier, vol. 111(2), pages 450-468.
  7. Bussière, M. & Ristiniemi, A., 2012. "Credit Ratings and Debt Crises," Working papers 396, Banque de France.
  8. Matthias Efing, 2013. "Bank Capital Regulation with an Opportunistic Rating Agency," CESifo Working Paper Series 4267, CESifo Group Munich.
  9. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.
  10. Harold L. Cole & Thomas F. Cooley, 2014. "Rating Agencies," NBER Working Papers 19972, National Bureau of Economic Research, Inc.
  11. Bo Becker & Marcus Opp, 2013. "Replacing Ratings," NBER Working Papers 19257, National Bureau of Economic Research, Inc.

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