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Credit Ratings and Investments

Author

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  • Anna Bayona
  • Oana Peia
  • Razvan Vlahu

Abstract

We study how inflated credit ratings affect investment decisions in bond markets using experimental coordination games. Theoretical models that feature a feedback effect between capital markets and the real economy suggest that inflated ratings can have both positive and negative real effects. We compare markets with and without a credit rating agency and find that ratings significantly impact investor behaviour and capital allocation to firms. We show that the main mechanism through which these real effects materialize is a shift in investors’ beliefs about the behaviour of other investors rather than firms’ underlying fundamentals. Our experimental results sug- gest that the positive impact of inflated ratings is likely to dominate in the presence of feedback effects since ratings act as a strong coordination mechanism resulting in enhanced market outcomes.

Suggested Citation

  • Anna Bayona & Oana Peia & Razvan Vlahu, 2023. "Credit Ratings and Investments," Working Papers 776, DNB.
    • Handle: RePEc:dnb:dnbwpp:776
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    File URL: https://www.dnb.nl/media/zahliw0m/working_paper_no-776.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit ratings; Imperfect information; Investor beliefs; Firm financing;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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