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Risk, ambiguity, and sovereign rating

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  • Paolo Caro

Abstract

Decisions of investing in sovereign assets involve both risk and ambiguity. Ambiguity arises from unknown elements characterizing the value of a generic sovereign. In presence of ambiguity, ambiguity-averse investors are prone to pay for obtaining summary information such as ratings which reduces ambiguity. Ambiguity-neutral and ambiguity-averse investors, then, make decisions on the basis of different informative sources. By presenting a simple model of sovereign rating under ambiguity, three facts occurring in today’s financial markets are explained. Sovereign ratings influence decisions of investment of ambiguity-sensitive individuals. Rating-dependent regulations create distortions in financial markets by institutionalising specific summary signals. Providing ratings may be a profitable activity. Some final suggestions propose future areas of theoretical and empirical research. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Paolo Caro, 2015. "Risk, ambiguity, and sovereign rating," International Economics and Economic Policy, Springer, vol. 12(1), pages 41-57, March.
    • Handle: RePEc:kap:iecepo:v:12:y:2015:i:1:p:41-57
    DOI: 10.1007/s10368-014-0279-6
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    More about this item

    Keywords

    Risk; Ambiguity; Ambiguity aversion; Sovereign rating; Value of information; D80; D81; G11; G14;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G1 - Financial Economics - - General Financial Markets

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